Interest Rate Option Markets: The Role of Liquidity in Volatility Smiles

Deuskar, P and Gupta, A and Subrahmanyam, M G (2008) Interest Rate Option Markets: The Role of Liquidity in Volatility Smiles. Working Paper. SSRN. (Unpublished)

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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.

Affiliation: Indian School of Business
ISB Creators:
ISB CreatorsORCiD
Deuskar, PUNSPECIFIED
Item Type: Monograph (Working Paper)
Uncontrolled Keywords: Volatility smiles, liquidity, interest rate options, euro interest rate markets, Euribor market
Subjects: Financial Management
Depositing User: Ilayaraja M
Date Deposited: 19 May 2019 13:47
Last Modified: 19 May 2019 13:47
URI: http://eprints.exchange.isb.edu/id/eprint/1017
Publisher URL: https://ssrn.com/abstract=1295852
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