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The Swaption Cube

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  • Anders B. Trolle
  • Eduardo S. Schwartz

Abstract

We infer conditional swap rate moments model independently from swaption cubes. Conditional volatility and skewness exhibit systematic variation across swap maturities and option expiries (conditional kurtosis less so), with conditional skewness sometimes changing sign. Conditional skewness displays some relation to the level and volatility of swap rates but is most consistently related to the conditional correlation between swap rates and swap rate variances. From realized excess returns on synthetic variance and skewness swap contracts, we infer that variance and (to a lesser extent) skewness risk premia are negative and time varying. For the most part, results hold true in both the USD and EUR markets and in both precrisis and crisis subsamples. We design and estimate a dynamic term structure model that captures much of the dynamics of conditional swap rate moments.

Suggested Citation

  • Anders B. Trolle & Eduardo S. Schwartz, 2014. "The Swaption Cube," The Review of Financial Studies, Society for Financial Studies, vol. 27(8), pages 2307-2353.
  • Handle: RePEc:oup:rfinst:v:27:y:2014:i:8:p:2307-2353.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhu015
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    Cited by:

    1. Michael Bauer & Mikhail Chernov, 2024. "Interest Rate Skewness and Biased Beliefs," Journal of Finance, American Finance Association, vol. 79(1), pages 173-217, February.
    2. Markellos, Raphael N. & Psychoyios, Dimitris, 2018. "Interest rate volatility and risk management: Evidence from CBOE Treasury options," The Quarterly Review of Economics and Finance, Elsevier, vol. 68(C), pages 190-202.
    3. Duyvesteyn, Johan & de Zwart, Gerben, 2015. "Riding the swaption curve," Journal of Banking & Finance, Elsevier, vol. 59(C), pages 57-75.
    4. Frédéric Vrins & Linqi Wang, 2023. "Asymmetric short-rate model without lower bound," Quantitative Finance, Taylor & Francis Journals, vol. 23(2), pages 279-295, February.
    5. Manuel Ammann & Mathis Mörke, 2019. "Credit Variance Risk Premiums," Working Papers on Finance 1908, University of St. Gallen, School of Finance.
    6. Xiaoxi Liu & Jinming Xie, 2023. "Forecasting swap rate volatility with information from swaptions," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(4), pages 455-479, April.
    7. Li, Jing & Li, Lingfei & Zhang, Gongqiu, 2017. "Pure jump models for pricing and hedging VIX derivatives," Journal of Economic Dynamics and Control, Elsevier, vol. 74(C), pages 28-55.
    8. Hain, Martin & Uhrig-Homburg, Marliese & Unger, Nils, 2018. "Risk factors and their associated risk premia: An empirical analysis of the crude oil market," Journal of Banking & Finance, Elsevier, vol. 95(C), pages 44-63.
    9. Aşty Al-Jaaf, 2022. "Dividend predictability and higher moment risk premia," Journal of Asset Management, Palgrave Macmillan, vol. 23(2), pages 83-99, March.
    10. Scott Joslin, 2018. "Can Unspanned Stochastic Volatility Models Explain the Cross Section of Bond Volatilities?," Management Science, INFORMS, vol. 64(4), pages 1707-1726, April.

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