Riding the Swaption Curve
61 Pages Posted: 21 Feb 2012 Last revised: 25 Jan 2016
Date Written: March 20, 2015
We conduct an empirical analysis of the term structure in the volatility risk premium in the fixed income market by constructing long-short combinations of two at-the-money straddles for the four major swaption markets (USD, JPY, EUR and GBP). Our findings are consistent with a concave, upward-sloping maturity structure for all markets, with the largest negative premium for the shortest term maturity. The fact that both delta-vega and delta-gamma neutral straddle combinations earn positive returns that seem uncorrelated suggests that the term structure is affected by both jump risk and volatility risk. The results seem robust for macroeconomic announcements and the specific model choice to estimate the risk exposures for hedging.
Keywords: Volatility risk premium, Term structure, Swaptions, Straddles, Bonds, Interest rate derivatives
JEL Classification: G120, G130, G140
Suggested Citation: Suggested Citation