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Are Interest Rate Derivatives Spanned by the Term Structure of Interest Rates?

  • Massoud Heidari

    (Caspian Capital)

  • Liuren WU

    (Fordham University)

We investigate whether the same finite dimensional dynamic system spans both interest rates (the yield curve) and interest rate options (the implied volatility surface). We find that the options market exhibits factors independent of the underlying yield curve. While three common factors are adequate to capture the systematic movement of the yield curve, we need three additional factors to capture the movement of the implied volatility surface.

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File URL: http://econwpa.repec.org/eps/fin/papers/0207/0207013.pdf
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Paper provided by EconWPA in its series Finance with number 0207013.

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Length: 48 pages
Date of creation: 30 Aug 2002
Date of revision:
Handle: RePEc:wpa:wuwpfi:0207013
Note: Type of Document - pdf; prepared on MikTex; to print on postscript; pages: 48 ; figures: included. produced via dvipdfm
Contact details of provider: Web page: http://econwpa.repec.org

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  17. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  18. Peter Carr & Liuren Wu, 2002. "The Finite Moment Log Stable Process and Option Pricing," Finance 0207012, EconWPA.
  19. Haugen, Robert A & Talmor, Eli & Torous, Walter N, 1991. " The Effect of Volatility Changes on the Level of Stock Prices and Subsequent Expected Returns," Journal of Finance, American Finance Association, vol. 46(3), pages 985-1007, July.
  20. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, vol. 63(1), pages 3-50, January.
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