Identifying volatility risk premia from fixed income Asian options
Caio Almeida () and
José Valentim Vicente
Journal of Banking & Finance, 2009, vol. 33, issue 4, 652-661
Fixed income options are frequently adopted by companies to hedge interest rate risk. Their payoff dependence on the cumulative short-term rate makes them particularly informative about interest rate volatility risk. Based on a joint dataset of bonds and Asian interest rate options, we study the interrelations between bond and volatility risk premia in a major emerging fixed income market. We propose a dynamic term structure model that generates an incomplete market compatible with a preliminary empirical analysis of the dataset. Approximation formulas for at-the-money Asian option prices avoid the use of computationally intensive Fourier transform methods, allowing for an efficient implementation of the model. The model generates a bond risk premium strongly correlated with a widely accepted emerging market benchmark index (EMBI-Global), and a negative volatility risk premium, consistent with the use of Asian options as insurance in this market.
Keywords: Asian; options; Risk; premium; Stochastic; volatility; Incomplete; markets (search for similar items in EconPapers)
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Working Paper: Identifying Volatility Risk Premium from Fixed Income Asian Options (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:33:y:2009:i:4:p:652-661
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