The Effect of Dynamic Hedging of Options Positions on Intermediate-Maturity Interest Rates
When interest rates change, interest rate options dealers buy or sell securities to adjust the hedging positions that they have taken in order to offset their options exposures. The net result of this trading activity, which is unrelated to economic fundamentals, can be to push interest rates further in the direction they were moving. Such “feedback” effects interfere with the short-term dynamics of interest rate movements and can alter the shape of the yield curve, especially when changes in interest rates are large. Our empirical results confirm the existence of a positive feedback from the activity in the euro-denominated interest rate options market to the european yield curve. This finding can be useful for risk management purposes but also for analysts and policy makers when interpreting short-run movements in the yield curve as signals of future economic activity.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Clewlow, Les & Hodges, Stewart, 1997. "Optimal delta-hedging under transactions costs," Journal of Economic Dynamics and Control, Elsevier, vol. 21(8-9), pages 1353-1376, June.
- Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
- Osterwald-Lenum, Michael, 1992. "A Note with Quantiles of the Asymptotic Distribution of the Maximum Likelihood Cointegration Rank Test Statistics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 461-72, August.
- Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
- Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
- Bertsimas, Dimitris & Kogan, Leonid & Lo, Andrew W., 2000. "When is time continuous?," Journal of Financial Economics, Elsevier, vol. 55(2), pages 173-204, February.
When requesting a correction, please mention this item's handle: RePEc:bog:wpaper:08. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christina Tsochatzi)
If references are entirely missing, you can add them using this form.