(Question)
"The variance of daily interest rate changes has been trending higher over the past three months, leading us to believe that a period of high volatility is approaching in the next 12 to 18 months. However, the reliability is questionable because the volatility estimates were derived using an option pricing model, which assumes constant interest rates."
Is this statement correct?
Answer: No. It's incorrect.
Option pricing models assumes a constant volatility of interest rates but not a constant level of interest rates.
Friday, March 4, 2011
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