Dynamics of Interest Rate Swap and Equity Volatilities

CBOE RMC Europe, 7 Sep 2012

Presented by Yoshiki Obayashi, Applied Academics LLC
Based on work in collaboraEon with: Antonio Mele, QUASaR QuanEtaEve Strategies and Research Catherine Shalen, Chicago Board OpEons Exchange

CBOE SRVX Index

Launched in June 2012 as a benchmark for tracking interest rate swap volaElity Methodology based on model-free pricing of a variance swap by a strip of swapEons

A related but disEnct risk vis--vis VIX, rich Eme- varying dynamics

Snapshot of Swap Volatility

Slice Along the 10Y Tenor
Vol-of-vol increases with shorter forward horizon SRVX vs ATM volatility Time-varying slopes

210 160 110 60

2/1/07 2/1/08 2/1/09 2/1/10

3M 10Y 1Y 10Y 2Y 10Y

2/1/11

2/1/12

SRVX vs ATM Implied Vol

SRVX vs 3m-1y Slope

Equity vs. Rates Vol (Realized)

1-month realized daily volatilities
Realized equity volatility vs rates volatility Similarities and differences

1-year rolling correlation

100

Time-varying correlaEon

80 60 40 20 0 -20 -40 -60 -80 1996 1998 2000 2002 2004 2006 2008 2010 2012

Equity vs. Rates Vol (Implied)

VIX vs. SRVX Implied Volatility
Extended periods of divergence Responses to different events Different levels of correlation with macro factors
200 100

SRVX Index

100

50

0 2007

2008

2009

2010

2011

2012

0 2013

Correlations Table

Levels SRVX VIX

S&P 500 -77% -71%

Fwd Swap -13% -26%

Ind. Prod. -73% -39%

DXY -1% 46%

VIX Index

Realized vs Implied: Risk Premium

Equity Variance Risk Premium
Mostly positive premium with infrequent but sharp reversals

Swap Variance Risk Premium

More persistent than 1m equity Changes in SRVX and premium explain 32% of variation in forward rate changes

Volatility of Volatility
Volatility of the VIX and SRVX
Index volatilities vary greatly over time Marked divergences in index volatilities, especially during height of crisis Different magnitudes of index volatilities
Volatility of the VIX Index, annualized, %

400

100

200

50

0 2007

2008

2009

2010

2011

2012

0 2013

Volatility of the SRVX Index, annualized, %

SRVX and Macro Variables

Industrial Production Growth
30

MBA Refinancing Index

Weekly changes in the SRVX Index, 1Y-10Y

20

10

-10

-20

-30 -4000

-3000

-2000 -1000 0 1000 Weekly changes in the mortgage REFI Index

2000

3000

Forecast Regression d(IP) = c + b1 x lag(VRP_Swap) + b2 x lag(VRP_S&P) + b3 x lag(U.Mich) + e Adj. R-Sq = 0.24 {c,b1,b3} = significant at 1% level

Contemporaneous Regression d(REFI) = c + b1 x d (SRVX) + b2 x d(VRP_Swap) + b3 x dlag(REFI) + e Adj. R-Sq = 0.19 {b1,b2} = significant at 1% level

Future Development of SRVX

CreaEon of futures, opEons, and structured products based on CBOE SRVX Complementary tool to the CBOE VIX in macro volaElity trading and strategy research Further analysis of SRVX as a forecasEng tool Data Sources: Chicago Board OpEons Exchange and Bloomberg LP
Note: Historical SRVX values herein are indicaEve and subject to change
Important Disclaimer: The informaEon contained in this presentaEon is provided for educa&onal purposes only, and does not consEtute investment, securi&es or trading advice.