Implicit Entropic Market Risk-Premium from Interest Rate Derivatives

J. Arismendi-Zambrano and R. Azevedo ()
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J. Arismendi-Zambrano: Department of Economics, Finance and Accounting, Maynooth University, Ireland & ICMA Centre, Henley Business School, University of Reading, Whiteknights, Reading, United Kingdom.
R. Azevedo: Bradesco Asset Management - BRAM, Sao Paulo, Brazil
Authors registered in the RePEc Author Service: Juan Carlos Arismendi Zambrano ()

Economics Department Working Paper Series from Department of Economics, National University of Ireland - Maynooth

Abstract: Implicit in interest rate derivatives are Arrow-Debreu prices (or state price densities, SPDs) that contain fundamental information for risk and portfolio management in interest rate markets. To extract such information from interest rate derivatives, we propose a nonparametric method to estimate state prices based on the minimization of the Cressie-Read (Entropic) family function between potential SPDs and the empirical probability measure. An empirical application of the method, in the US interest rates and derivatives market, shows that the entropic based risk-neutral density measure highlight potential risks previous to the 2007/2008 financial crisis, and the potential arbitrage burden during the Quantitative Easing period.

Keywords: Risk management; Risk analysis; Nonparametric Asset Pricing; State Price Density; Interest Rate Derivatives (search for similar items in EconPapers)
JEL-codes: C14 G12 G13 G14 G18 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2020
New Economics Papers: this item is included in nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:may:mayecw:n303-20.pdf

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