The Term Structure of Government Debt Uncertainty

Antonio Mele, Yoshiki Obayashi and Shihao Yang

No 13874, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: How valuable would it be to mitigate government debt volatility? This paper introduces a model that accounts for the complex structure of expected volatility in government bond markets and provides predictions regarding the fair value of derivatives referenced to this expected volatility. The model predicts that, unlike equity markets, futures markets on government bond volatilities frequently oscillate between episodes of backwardation and contango. This property helps explain events such as the reaction of the U.S. Treasury volatility curve to shocks including unanticipated Fed decisions or global economic imbalances. The paper provides quasi-closed form solutions that can readily be implemented despite the high-dimensional no-arbitrage restrictions that underlie the model dynamics.

Keywords: Fixed income volatility; Information content of government bond volatility; Government bond variance swaps; Treasury markets (search for similar items in EconPapers)
JEL-codes: E43 E44 G12 G13 (search for similar items in EconPapers)
Date: 2019-07
New Economics Papers: this item is included in nep-mac and nep-rmg
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