Spanned stochastic volatility in bond markets
Subtitle: a reexamination of the relative pricing between bonds and bond options
By: by Don H. Kim.
Contributors: Bank for International Settlements. Monetary and Economic Dept.
Series: BIS working papers -- no. 239
Publisher: Bank for International Settlements
Published: 2007
Place of publication: Basel, Switzerland
Language: eng
Format: Electronic resource
Description: This paper reexamines the issue of unspanned stochastic volatility (USV) in bond markets and the puzzle of poor relative pricing between bonds and bond options. I make a distinction between the "weak USV" and the "strong USV" scenarios, and analyze the evidence for each of them. I argue that the poor bonds/options relative pricing in the extant literature is not necessarily evidence for the strong USV scenario, and show that a maximally flexible 2-factor quadratic-Gaussian model (a non-USV model) estimated without bond options data can capture much of the movement in bond option prices. Dropping the positive-definiteness requirement for nominal interest rates and adopting "regularized" estimations turn out to be important for obtaining sensible results.
Notes: Title from PDF file (viewed on Dec. 27, 2007).

"Monetary and Economic Department."

"December 2007."

Includes bibliographical references.

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