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An affine term structure model for Turkish interest rate swap market: do swaps span volatility risk?

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2019
Özbekler, Ali Genca
We follow novel procedure of [4] to assess presence of unspanned stochastic volatility (USV) phenomenon in the Turkish lira interest rate swap (IRS) market. The estimations reveal that IRS yield curve dynamics fail to span volatility in IRS market and thus volatility risk cannot be hedged using only IRS instruments. The major implication of USV is then used to investigate the systemic volatility in domestic markets. In this scope, we employ USV condition as a specification for affine term structure (AFTS) models. Comparing AFTS models with stochastic and constant volatility, we find that three-factor constant volatility model provides more robust estimation results in terms of both volatility and yield fitting.