The Price of Government Bond Volatility

Antonio Mele and Yoshiki Obayashi
Additional contact information
Yoshiki Obayashi: Applied Academics LLC

No 13-27, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: Treasury price volatility comoves with equity volatility quite heterogeneously over time, with correlations ranging from negative to positive, and marked by periods of rapid movement. What is the price of Treasury volatility? How can we express this price in a model-free format? Despite the success of the CBOE equity VIX, no counterparts exist for US Treasuries and other government bond markets. Pricing Treasury price volatility in a model-free manner is a delicate issue for two reasons. First, volatility is referenced to an asset with finite maturity, a case where standard spanning arguments might fail to apply. Second, the markets we are interested in this paper obviously relate to contexts where interest rates are random, which requires tilting the basis assets we wish to price the volatility of. We develop contract designs for variance swaps applying to government bonds, and derive model-free indexes of government bond price expected volatility, based on the fair value of the contracts expressed in terms of option prices. We follow market practice and consider both percentage and basis point expected volatility. Basis point volatility can be priced in a model-free format even in the presence of jumps. We provide two algorithms to calculate the indexes through the use of American future options.

Keywords: Interest Rate Volatility; Interest Rate Variance Swaps; Model-Free Pricing; VIX Index; Basis Point Variance; Basis Point Yield Volatility; Quadratic Contracts (search for similar items in EconPapers)
JEL-codes: E4 G11 G12 G13 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2013-04
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2255553 (application/pdf)

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:chf:rpseri:rp1327

Access Statistics for this paper

More papers in Swiss Finance Institute Research Paper Series from Swiss Finance Institute Contact information at EDIRC.
Bibliographic data for series maintained by Ridima Mittal ().