Fixed–income volatility management

Fong, H. Gifford; Vasicek, Oldrich A

doi:10.3905/jpm.1991.409345

Cited by 77 publications

(56 citation statements)

References 2 publications

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“…The R 2 are quite low, implying that portfolios of bonds (or equivalently, swaps) have very limited ability to hedge volatility risk. We emphasize that these findings are inconsistent with the predictions of the traditional term structure models with stochastic volatility (such as Fong and Vasicek (1991), Longstaff and Schwartz (1992), Chen andScott (1993), andDK (1996)). Indeed, as we show in Section II.D., replicating the above regression in a simulated traditional affine economy would result in an R 2 well above 90 percent.…”

Section: Ib Methodology and Resultscontrasting

confidence: 54%

“…The bivariate affine models of Fong and Vasicek (1991) and Longstaff and Schwartz (1992) were the first term structure models to incorporate stochastic volatility into a fixed-income framework.…”

Section: Iia Bivariate Affine Usv Modelsmentioning

confidence: 99%

“…After providing a formal definition of USV, we show that it is not possible for bivariate Markov affine models to exhibit such behavior, thus ruling out the models of Fong and Vasicek (1991), Longstaff and Schwartz (1992), and Chen and Scott (1993) as potential candidates. More generally, we demonstrate that even non-affine bivariate models of the short rate cannot generate USV.…”

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confidence: 99%

“…Because all state variables show up in bond prices, these models predict that all sources of risk affecting fixed income derivatives can be completely hedged by a portfolio consisting solely of bonds. For example, the stochastic volatility models of Fong and Vasicek (1991) and Longstaff and Schwartz (1992) generate bond yields that are linear in both the spot rate and the volatility state variables. Hence, these models predict that bonds can be used to hedge volatility risk.…”

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confidence: 99%

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Do Bonds Span the Fixed Income Markets? Theory and Evidence for Unspanned Stochastic Volatility

Collin‐Dufresne

Goldstein

2001

SSRN Journal

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Most term structure models assume bond markets are complete, i.e., that all fixed income derivatives can be perfectly replicated using solely bonds. However, we find that, in practice, swap rates have limited explanatory power for returns on at-the-money straddlesportfolios mainly exposed to volatility risk. We term this empirical feature "unspanned stochastic volatility" (USV). While USV can be captured within an HJM framework, we demonstrate that bivariate models cannot exhibit USV. We determine necessary and sufficient conditions for trivariate Markov affine systems to exhibit USV. For such USVmodels, bonds alone may not be sufficient to identify all parameters. Rather, derivatives are needed.

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Section: Ib Methodology and Resultscontrasting

confidence: 54%

Section: Iia Bivariate Affine Usv Modelsmentioning

confidence: 99%

mentioning

confidence: 99%

mentioning

confidence: 99%

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Do Bonds Span the Fixed Income Markets? Theory and Evidence for Unspanned Stochastic Volatility

Collin‐Dufresne

Goldstein

2001

SSRN Journal

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“…find that excess returns on Treasury bills are strongly affected by the conditional volatility on an equally-weighted bill portfolio, which is taken as a unique common factor. Second, in a complementary study based on the Engle, Ng and Rothschild's model, Engle and Ng (1993) show that when volatility is high, the yield curve is likely to be upward sloped (see also Fong andVasicek, 1991, andSchwartz, 1993). Third, Litterman, Scheinkman and Weiss (1991) find that the curvature of the yield curve and the implied volatility extracted from bond options are strongly related.…”

Section: < Insert Table 3 >mentioning

confidence: 99%