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Model Insight - New Implied Volatility Factors in the Barra Integrated Model - July 2013

The valuation of a fixed income security depends on an interest rate model. For instruments with no embedded optionality, only the current term structure plays a role in valuation and risk analysis. In contrast, the uncertain character of future interest rates has a significant impact on the analysis of instruments with optionality; for example, callable bonds, mortgage pass-throughs, or explicit options like caps and swaptions. The implied volatility factors of the Barra Integrated Model (BIM) infer the market’s varying expectation of the volatility of the term structure and forecast the risk of volatility-sensitive securities. This Model Insight reviews the implied volatility factor model in BIM and introduces new implied volatility factor market coverage for Switzerland, Sweden, Canada and Australia.