Are interest rate options important for the assessment of interest rate risk?

Caio Almeida, José Vicente

Research output: Contribution to journalArticle

10 Scopus citations

Abstract

Fixed income options contain substantial information on the price of interest rate volatility risk. In this paper, we ask if those options will also provide information related to other moments of the objective distribution of interest rates. Based on dynamic term structure models within the class of affine models, we find that interest rate options are useful for the identification of interest rate quantiles. Two three-factor models are adopted and their adequacy to estimate Value at Risk of zero-coupon bonds is tested. We find significant difference on the quantitative assessment of risk when options are (or not) included in the estimation process of each of these dynamic models. Statistical backtests indicate that bond estimated risk is clearly more adequate when options are adopted, although not yet completely satisfactory.

Original languageEnglish (US)
Pages (from-to)1376-1387
Number of pages12
JournalJournal of Banking and Finance
Volume33
Issue number8
DOIs
StatePublished - Aug 2009
Externally publishedYes

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Keywords

  • Backtesting procedures
  • Dynamic term structure models
  • Feller processes
  • Laplace transform
  • Value at Risk

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