Implied volatility indices have mushroomed over the last decade in international equity markets. Specifically, newly created volatility indices follow the VIX methodology implemented by the Chicago Board of Options Exchange in 2003. In this thesis, we construct two different sets of implied volatility indices for the US fixed-income market and analyze whether documented properties of equity-based volatility indices apply to fixed-income volatility indices. The first set of volatility indices, which are named interest rate volatility indices (IRVIXs), reflect the market expectations of volatility of short-term interest rates over both short- and long-term horizons (from one to ten years). To this end, we use the implied volatilities of caplets (floorlets) recovered from the implied volatility quotes of caps (floors). Based on IRVIXs, we investigate two stylized facts of equity-based volatility indices, namely, the negative correlation with the underlying asset and the presence of implied volatility spillovers across international equity markets. We find that IRVIXs are negatively correlated with the underlying forward interest rates and that there is evidence of implied volatility transmission not only across international equity markets but also across equity and fixed-income markets. The second set of fixed-income volatility indices that we develop in this thesis capture the market expected volatility of five-year and ten-year Treasury notes and 30-year Treasury bond futures over the remaining 30 days. These are named Treasury bond volatility indices (TBVIXs). We calculate TBVIXs based on the concept of the model-free implied variance derived by Britten-Jones and Neuberger (2000), which is closely related to the VIX formula. We employ the Treasury bond volatility indices to investigate whether two additional features of equity-based volatility indices which have been reported in the literature hold. On the one hand, we obtain that TBVIXs spike upward during unexpected market and global events such as the Kuwait invasion by Iraq or the more recent Lehman Brothers failure. On the other hand, we find evidence that TBVIXs fall following scheduled news announcements about macroeconomic fundamentals such as the nonfarm payrolls report or Federal Open Market Committee meetings. Thus, these findings are consistent with the empirical evidence from equity-based volatility indices.
References:
Britten-Jones, M., Neuberger, A., 2000. Option Prices, Implied Price Processes, and Stochastic Volatility. Journal of Finance 55, 839-866.