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Interest rate options dealers' hedging in the US dollar fixed income market

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  • John Kambhu

Abstract

The potential for the dynamic hedging of written options to lead to positive feedback in asset price dynamics has received repeated attention in the literature on financial derivatives. Using data on OTC interest rate options from a recent survey of global derivatives markets, this paper addresses the question whether that potential for positive feedback is likely to be realized. With the possible exception of the medium term segment of the term structure, transaction volume in available hedging instruments is sufficiently large to absorb the demands resulting from the dynamic hedging of US dollar interest rate options even in response to large interest rate shocks.

Suggested Citation

  • John Kambhu, 1997. "Interest rate options dealers' hedging in the US dollar fixed income market," Research Paper 9719, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednrp:9719
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    References listed on IDEAS

    as
    1. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-395, June.
    2. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
    3. Grossman, Sanford J, 1988. "An Analysis of the Implications for Stock and Futures Price Volatility of Program Trading and Dynamic Hedging Strategies," The Journal of Business, University of Chicago Press, vol. 61(3), pages 275-298, July.
    4. Julia Fernald & Patricia C. Mosser & Frank Keane, 1994. "Mortgage security hedging and the yield curve," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 92-100.
    5. Michael J. Fleming, 1997. "The round-the-clock market for U.S. Treasury securities," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 9-32.
    6. Bernanke, Ben S, 1990. "Clearing and Settlement during the Crash," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 133-151.
    7. Lisa N. Galaif, 1993. "Index amortizing rate swaps," Quarterly Review, Federal Reserve Bank of New York, issue Win, pages 63-70.
    8. John Kambhu & Frank M. Keane & Catherine Benadon, 1996. "Price risk intermediation in the over-the-counter derivatives markets: interpretation of a global survey," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 1-15.
    9. Jameson, Mel & Wilhelm, William, 1992. " Market Making in the Options Markets and the Costs of Discrete Hedge Rebalancing," Journal of Finance, American Finance Association, vol. 47(2), pages 765-779, June.
    10. Julia Fernald & Patricia C. Mosser & Frank Keane, 1994. "Mortgage security hedging and the yield curve," Research Paper 9411, Federal Reserve Bank of New York.
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