Are Interest Rate Options Important for the Assessment of Interest Rate Risk?

32 Pages Posted: 21 Mar 2018

See all articles by Caio Almeida

Caio Almeida

Getulio Vargas Foundation ; Princeton University

Jose Vicente

Government of the Federative Republic of Brazil - Central Bank of Brazil; Ibmec, Rio de Janeiro - IBMEC Business School

Date Written: December 2008

Abstract

Fixed income options contain substantial information on the price of interest rate volatility risk. In this paper, we ask if those options will also provide information related to other moments of the objective distribution of interest rates. Based on dynamic term structure models within the class of affine models, we find that interest rate options are useful for the identification of interest rate quantiles. Two three-factor models are adopted and their adequacy to estimate Value at Risk of zero coupon bonds is tested. We find significant difference on the quantitative assessment of risk when options are (or not) included in the estimation process of each of these dynamic models. Statistical backtests indicate that bond estimated risk is clearly more adequate when options are adopted, although not yet completely satisfactory.

Keywords: Dynamic term structure models, Value at risk, Back-testing procedures, Laplace Transform, Feller processes

JEL Classification: C13 , G12 , G13

Suggested Citation

Almeida, Caio and Vicente, Jose, Are Interest Rate Options Important for the Assessment of Interest Rate Risk? (December 2008). Available at SSRN: https://ssrn.com/abstract=3142982 or http://dx.doi.org/10.2139/ssrn.3142982

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

Jose Vicente

Government of the Federative Republic of Brazil - Central Bank of Brazil

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Ibmec, Rio de Janeiro - IBMEC Business School

SCN Quadra 2, Bloco A, 2nd. floor
Ed. Corporate Financial Center
Brasília, 707712-900
Brazil

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