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Information content and market liquidity in the fixed income market: Evidence from the swaption market

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  • Hattori, Takahiro

Abstract

In this paper, I investigate the relationship between market liquidity and the information content of implied volatility (IV) in the fixed income market. For its part, financial regulation including Basel III relies heavily on historical volatility (HV) in capturing the financial risk of financial institutions. One of the main reasons for this is that many countries may not necessarily obtain a meaningful measure of IV in their option markets because of the lack of liquidity. Using US dollar and Japanese yen swaption data, I find that the information content of IV critically depends on the measure of liquidity. This finding empirically justifies the use of HV instead of IV as a financial risk measure, especially in countries where option market liquidity is low.

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  • 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).
    • Handle: RePEc:eee:finlet:v:45:y:2022:i:c:s1544612321001987
    DOI: 10.1016/j.frl.2021.102117
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    More about this item

    Keywords

    Information content; Market liquidity; Swaptions; Implied volatility; Historical volatility;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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