Do Interest Rate Options Contain Information About Excess Returns?

35 Pages Posted: 17 Feb 2018

See all articles by Caio Almeida

Caio Almeida

Getulio Vargas Foundation ; Princeton University

Jeremy J. Graveline

University of Minnesota - Carlson School of Management

Scott Joslin

University of Southern California

Date Written: October 18, 2010

Abstract

There is strong empirical evidence that long-term interest rates contain a time-varying risk premium. Options may contain valuable information about this risk premium because their prices are sensitive to the underlying interest rates. We use the joint time-series of swap rates and interest rate option prices to estimate dynamic term structure models. The risk premiums that we estimate using option prices are better able to predict excess returns for long-term swaps over short-term swaps. Moreover, in contrast to previous literature, the most successful models for predicting excess returns have risk factors with stochastic volatility. We also show that the stochastic volatility models we estimate using option prices match the failure of the expectations hypothesis.

Keywords: interest rates, options, risk premia, excess returns, forecasting

JEL Classification: C53, C58, E43, E47, G12

Suggested Citation

Almeida, Caio and Graveline, Jeremy J. and Joslin, Scott, Do Interest Rate Options Contain Information About Excess Returns? (October 18, 2010). Available at SSRN: https://ssrn.com/abstract=3120139 or http://dx.doi.org/10.2139/ssrn.3120139

Caio Almeida (Contact Author)

Getulio Vargas Foundation ( email )

Praia de Botafogo 190, 11o andar
Botafogo
Rio de Janeiro, Rio de Janeiro 22250-900
Brazil
5521-37995827 (Phone)
5521-2553-8821 (Fax)

HOME PAGE: http://www.fgv.br/professor/calmeida/

Princeton University ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

Jeremy J. Graveline

University of Minnesota - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-626-7817 (Phone)

HOME PAGE: http://www.tc.umn.edu/~jeremy/

Scott Joslin

University of Southern California ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
22
Abstract Views
250
PlumX Metrics