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Using the right implied volatility quotes in times of low interest rates: An empirical analysis across different currencies

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  • Patel, Jinal
  • Russo, Vincenzo
  • Fabozzi, Frank J.

Abstract

Negative rates directly impact the pricing and quoting of debt instruments, both guided by underlying rate models grounded in the assumption of nonnegative rates. In this paper, we calibrate three short-rate models – Hull–White, shift-extended Cox–Ingersoll–Ross, and shift-extended squared Gaussian – to negative rates environment. We use different market quotation methods for swaptions including Black, Bachelier, and shifted log-normal volatilities quoted for different currencies, specifically EUR, USD, GBP, and JPY. Our results suggest that the models studied can be effectively recalibrated in negative interest rate environments and that both existing and new quotation conventions are able to produce adequate calibration results.

Suggested Citation

  • Patel, Jinal & Russo, Vincenzo & Fabozzi, Frank J., 2018. "Using the right implied volatility quotes in times of low interest rates: An empirical analysis across different currencies," Finance Research Letters, Elsevier, vol. 25(C), pages 196-201.
    • Handle: RePEc:eee:finlet:v:25:y:2018:i:c:p:196-201
    DOI: 10.1016/j.frl.2017.10.013
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    1. repec:bla:jfinan:v:44:y:1989:i:1:p:205-09 is not listed on IDEAS
    2. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    3. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    4. Rubinstein, Mark, 1983. "Displaced Diffusion Option Pricing," Journal of Finance, American Finance Association, vol. 38(1), pages 213-217, March.
    5. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
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    Cited by:

    1. Hattori, Takahiro, 2022. "Information content and market liquidity in the fixed income market: Evidence from the swaption market," Finance Research Letters, Elsevier, vol. 45(C).

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