The Implied Volatility of U.S. Interest Rates: Evidence from Callable U.S. Treasuries

WP 95-12

Posted: 21 Jun 1998

See all articles by Robert R. Bliss

Robert R. Bliss

Wake Forest University - Schools of Business

Ehud I. Ronn

University of Texas at Austin - Department of Finance

Date Written: November 1995

Abstract

The prices for callable U.S. treasury securities provide the sole source of evidence concerning the implied volatility of interest rates over the extended 1926-1994 period. This paper uses the prices of callable as well as non-callable Treasury instruments to estimate implied interest rate volatilities for the past sixty years, and, for the more recent 1989-1994 period, the cross-sectional term structures of implied interest rate volatility. We utilize these estimates to perform cross-sectional richness/cheapness analysis across callable treasuries. Inter alia, we develop the optimal call policy for deferred "Bermuda"-style options for which prior notification of intent to call is required by introducing the concept of "threshold volatility" to measure the point when the time value of the embedded call option has been eroded to zero. This concept permits appropriate callable-bond valuation. Lastly, we document the optimality of the treasury's past call policy for U.S. government obligations.

JEL Classification: G13, H63

Suggested Citation

Bliss, Robert R. and Ronn, Ehud I., The Implied Volatility of U.S. Interest Rates: Evidence from Callable U.S. Treasuries (November 1995). WP 95-12, Available at SSRN: https://ssrn.com/abstract=7505

Robert R. Bliss (Contact Author)

Wake Forest University - Schools of Business ( email )

P.O. Box 7659
Winston-Salem, NC 27109-7285
United States

Ehud I. Ronn

University of Texas at Austin - Department of Finance ( email )

Graduate School of Business
Austin, TX 78712
United States
512-471-5853 (Phone)
512-471-5073 (Fax)

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