Interest Rate Options Dealers’ Hedging in the U.S. Dollar Fixed Income Market

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Research Papers

Interest Rate Options Dealers Hedging in the U.S. Dollar Fixed Income Market

May 1997 Number 9719

Author: John Kambhu

The potential for the dynamic hedging of written options to lead to positive feedback in asset price dynamics has received repeated attention in the literature on financial derivatives. Using data on OTC interest rate options from a recent survey of global derivatives markets, this paper addresses the question whether that potential for positive feedback is likely to be realized. With the possible exception of the medium term segment of the term structure, transaction volume in available hedging instruments is sufficiently large to absorb the demands resulting from the dynamic hedging of US dollar interest rate options even in response to large interest rate shocks.

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