TITLE:
Interest Rate Volatility: A Consol Rate Approach
AUTHORS:
Vincent Brousseau, Alain Durré
KEYWORDS:
Consol Rate, Historical Volatility, Overnight Money Market, Interbank Offered Interest Rates
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.5 No.1,
February
13,
2015
ABSTRACT: In this paper, we propose a new methodology to estimate the volatility of interest rates in the euro area money market. In particular, our approach aims at avoiding the limitations of market implied volatilities, i.e. the dependency on arbitrary choices in terms of maturity and frequencies and/or of other factors like credit and liquidity risks. The measure is constructed as the implied instantaneous volatility of a consol bond that would be priced on the EONIA swap curve over the sample period from 4 January 1999 to 21 November 2013. Our findings show that this measure tracks well the historical volatility since, by dividing the consol excess returns by our volatility measure. This removes nearly entirely excess of kurtosis and volatility clustering, bringing the excess returns close to an ordinary Gaussian white noise.