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Does Risk Pay? An Analysis of Short Gamma Trading Strategies and Volatility Forecasting in the Swaptions Market

By Tasha Staer Bollerslev

We evaluate short gamma trading strategies in the interest rate swaptions market from January 4th, 1999 to January 19th, 2007, and test the effectiveness of swaption proprietary forecasted volatility at predicting future realized volatility. We find that swaptions market proprietary forecasted volatility is an effective estimator; there is no risk premium priced into swaption prices and hence short gamma strategies are not profitable. We find that the market on average underprices interest rate swaptions by underestimating forward realized volatility.

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Advisor: Emma Rasiel

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