Information in the Term Structure of Yield Curve Volatility

Anna Cieślak · Pavol Povala

100 citations0/0 files storedThe Journal of Finance

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Stochastic processes and financial applications Financial Risk and Volatility Modeling Market Dynamics and Volatility

Abstract

ABSTRACT Using a novel no‐arbitrage model and extensive second‐moment data, we decompose conditional volatility of U.S. Treasury yields into volatilities of short‐rate expectations and term premia. Short‐rate expectations become more volatile than premia before recessions and during asset market distress. Correlation between shocks to premia and shocks to short‐rate expectations is close to zero on average and varies with the monetary policy stance. While Treasuries are nearly unexposed to variance shocks, investors pay a premium for hedging variance risk with derivatives. We illustrate the dynamics of the yield volatility components during and after the financial crisis.

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References

1993A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options 1985A Theory of the Term Structure of Interest Rates 2016“Options, Futures, and Other Derivatives”1996A YIELD‐FACTOR MODEL OF INTEREST RATES 1991Common Factors Affecting Bond Returns 2000Specification Analysis of Affine Term Structure Models 1992An Empirical Comparison of Alternative Models of the Short-Term Interest Rate 2002Term Premia and Interest Rate Forecasts in Affine Models

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2016Bond Variance Risk Premiums 2020Nearly Exact Bayesian Estimation of Non-linear No-Arbitrage Term-Structure Models 2017Staying at zero with affine processes: An application to term structure modelling 2022Negative Interest Rate Policy and the Yield Curve 2015An explicitly solvable Heston model with stochastic interest rate 2016Risk Premia and Volatilities in a Nonlinear Term Structure Model

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