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Identifying Volatility Risk Premium from Fixed Income Asian Options

Caio Almeida () and José Valentim Vicente

No 136, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: We provide approximation formulas for at-the-money asian option prices to extract volatility risk premium from a joint dataset of bonds and option prices. The dynamic model generates stochastic volatility and a time-varying volatility risk premium, which explicitly depends on the average cross section of bond yields and on the time series behavior of option prices. When estimated using a joint dataset of Brazilian local bonds and asian options, the model generates bond risk premium strongly correlated (89%) with a widely accepted emerging markets benchmark index, and a negative volatility risk premium implying that investors might be using options as insurance in this market. Volatility premium explains a significant portion (32.5%) of bond premium, confirming that options are indeed important to identify risk premium in dynamic term structure models.

Date: 2007-05
New Economics Papers: this item is included in nep-sea and nep-upt
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Journal Article: Identifying volatility risk premia from fixed income Asian options (2009) Downloads
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