Information content and market liquidity in the fixed income market: Evidence from the swaption market

Takahiro Hattori

Finance Research Letters, 2022, vol. 45, issue C

Abstract: In this paper, I investigate the relationship between market liquidity and the information content of implied volatility (IV) in the fixed income market. For its part, financial regulation including Basel III relies heavily on historical volatility (HV) in capturing the financial risk of financial institutions. One of the main reasons for this is that many countries may not necessarily obtain a meaningful measure of IV in their option markets because of the lack of liquidity. Using US dollar and Japanese yen swaption data, I find that the information content of IV critically depends on the measure of liquidity. This finding empirically justifies the use of HV instead of IV as a financial risk measure, especially in countries where option market liquidity is low.

Keywords: Information content; Market liquidity; Swaptions; Implied volatility; Historical volatility (search for similar items in EconPapers)
JEL-codes: G12 G13 G14 G32 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:45:y:2022:i:c:s1544612321001987

DOI: 10.1016/j.frl.2021.102117

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