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Interest Rate Volatility and Business Cycle Expectations[Note a. aThe publication delays are based on the data releases ...]
Author(s) -
MartínezSerna MaríaIsabel,
Navarro Eliseo
Publication year - 2015
Publication title -
international finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.458
H-Index - 39
eISSN - 1468-2362
pISSN - 1367-0271
DOI - 10.1111/1468-2362.12061
Subject(s) - volatility (finance) , economics , business cycle , volatility swap , implied volatility , econometrics , volatility risk premium , explanatory power , volatility smile , forward volatility , robustness (evolution) , realized variance , financial economics , macroeconomics , philosophy , biochemistry , chemistry , epistemology , gene
One explanation for the usefulness of financial variables as tools for economic forecasting is that they embody individual and firm expectations of future economic conditions. In this paper, we analyse whether interest rate volatility contains information on agent expectations which are directly measured by confidence indicators. For the sake of robustness, we use several different expectation indicators for the two countries we analyse, the US and Germany. We propose using a forward‐looking measure of volatility: the implied volatility of one year cap options. We find that implied volatility adds explanatory power to the yield spread and to changes in the short rate, which are typical predictors of the business cycle, and outperforms realized volatility.