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Please use this identifier to cite or link to this item: http://hdl.handle.net/2451/26805

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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