Volatility risk premium in the interest rate market: Evidence from delta-hedged gains on USD interest rate swaps

Suk Joon Byun and Ki Cheon Chang

International Review of Financial Analysis, 2015, vol. 40, issue C, 88-102

Abstract: This study examines whether the interest rate market compensates for volatility risk. It demonstrates that the delta-hedged gain (DHG) method introduced by Bakshi and Kapadia (2003) shows the existence and sign of DHG in the interest rate swap markets where they use measures different from what Bakshi and Kapadia assumed. This finding is applied to the USD interest rate swap and swaption market. The result shows that, over the short term, there is negative compensation for volatility risk premiums, akin to the equity or currency markets. Over the long term, the signs of compensation change and regression tests show the possibility that the volatility risk premium in the interest rate market can be different from those in other asset markets. However, this interpretation entails an overlapping data problem that is not easy to overcome especially for the long term DHG data. The difference in interest rate market may be due to the fact that the interest rate swap market is different from the equity or currency markets in that it is more driven by financial institutions and option traders than by individuals or directional traders.

Keywords: Volatility risk premium; Interest rate swap; Delta-hedged gain (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S1057521915000691
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:40:y:2015:i:c:p:88-102

DOI: 10.1016/j.irfa.2015.03.018

Access Statistics for this article

International Review of Financial Analysis is currently edited by B.M. Lucey

More articles in International Review of Financial Analysis from Elsevier
Bibliographic data for series maintained by Catherine Liu ().