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Option-implied bond spread risk

Author

Listed:
  • Gergely Hudecz
  • Edmund Moshammer
  • Marco Onofri

Abstract

Government bond yield futures and related option contracts contain information on the asymmetry of interest rate risks. We construct probability distributions of market- implied bond yield expectations up to 90 calendar days ahead between January 2018 and December 2023. We derive daily distributions for German, French, and Italian bond yields as well as bivariate distributions using a copula to analyse tail risks in bond spread movement. We confirm options to be useful in predicting bond yields and spreads when benchmarking against backward-looking models. Furthermore, we find tail spread measures to be correlated with stock market volatility, inflation expectations, monetary policy surprises, and global economic conditions. In the period under scrutiny, the correlation between these indicators and the Italian spread tail is stronger than the one with the French measure. While changes in global economic conditions and central bank asset purchases strongly correlate with the Italian spread tail, these are less relevant for the French one.

Suggested Citation

  • Gergely Hudecz & Edmund Moshammer & Marco Onofri, 2024. "Option-implied bond spread risk," Working Papers 66, European Stability Mechanism, revised 25 Nov 2024.
    • Handle: RePEc:stm:wpaper:66
    as

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    File URL: https://www.esm.europa.eu/system/files/document/2024-11/WP%2066.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Financial market; sovereign bond yield; risk premium; euro area; option contract; risk-neutral distribution; probability density function; copula model;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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