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http://hdl.handle.net/2451/26805
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| Title: | Interest Rate Option Markets: The Role of Liquidity in Volatility Smiles |
| Authors: | Deuskar, Prachi
GUPTA, ANURAG
SUBRAHMANYAM, MARTI G. |
| Keywords: | Volatility smiles
liquidity
interest rate options
euro interestrate markets
Euribor market |
| Issue Date: | Nov-2004 |
| Series/Report no.: | S-DRP-04-03 |
| Abstract: | We investigate the interaction of volatility smiles and liquidity in the
euro (€) interest rate option markets, using daily bid and ask
prices of interest rate caps/floors. We find that liquidity variables
have significant explanatory power for both curvature and asymmetry of
the implied volatility smiles. This effect is generally stronger on the
ask side, indicating that ask-prices are more relevant for these
markets. In addition, the shape of the implied volatility smile has some
information about future levels and volatility of the term structure.
Our results have important implications for the modeling and risk
management of fixed income derivatives. |
| URI: | http://hdl.handle.net/2451/26805 |
| Appears in Collections: | Derivatives Research
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