30 Pages Posted: 26 Apr 2013
Date Written: April 23, 2013
Eurodollar deposit 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 time deposit volatility? How can we express this price in a model-free format? Despite the success of the CBOE equity VIX, no counterparts exist for time deposits such as the Eurodollar. Pricing time deposit volatility in a model-free manner is a delicate issue because the contexts we are interested in are obviously those where interest rates are random, requiring tilting the basis assets we wish to price the volatility of. We develop contract designs for variance swaps applying to time deposits, and derive model-free indexes of time deposit 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
JEL Classification: E4, G11, G12, G13
Suggested Citation: Suggested Citation
Mele, Antonio and Obayashi, Yoshiki, Volatility Indexes and Contracts for Eurodollar and Related Deposits (April 23, 2013). Swiss Finance Institute Research Paper No. 13-25. Available at SSRN: https://ssrn.com/abstract=2255583 or http://dx.doi.org/10.2139/ssrn.2255583
By Nengjiu Ju