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Term structure of volatilities and yield curve estimation methodology

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  • Antonio Diaz
  • Francisco Jareno
  • Eliseo Navarro

Abstract

In this paper, we estimate the term structure of interest rate volatilities. It is well known that volatility is the main input for option and other fixed income derivatives valuation models. However, we find that volatility estimates depend significantly on the model used to estimate the zero coupon yield curve (Nelson and Siegel; Vasicek and Fong) and the assumption concerning the heteroskedasticity structure of errors (OLS or GLS weighted by duration). We conclude in our empirical analysis that there are significant differences between these volatility estimates in the short term (less than one year) and in the long term (more than 10 years).

Suggested Citation

  • Antonio Diaz & Francisco Jareno & Eliseo Navarro, 2010. "Term structure of volatilities and yield curve estimation methodology," Quantitative Finance, Taylor & Francis Journals, vol. 11(4), pages 573-586.
    • Handle: RePEc:taf:quantf:v:11:y:2010:i:4:p:573-586
    DOI: 10.1080/14697680903473286
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    References listed on IDEAS

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