Implied Volatility

I was surprised to see in the readings that you could derive interest rate volatility using the implied vol generated from a BS model for the equity (I presume) of that company? Is this really apples to apples? Wouldn’t the implied volatility for the derivatives trading on an equity of a company be different from the interest rate volatility of that same company’s corporate bonds?

I don’t have a photographic memory, but I don’t recall seeing this. Do you have a reference to the text?

You can’t get interest rate volatility from anything B-S because the interest rate only affects option pricing in, um, a smooth kinda way. Hence an equity option has the same price under B-S regardless of interest rate vol.

It is mentioned in the text that you can derive implied volatility from observed prices in interest rate derivatives and option pricing models. This is mentioned in Reading 56 - Term Structure and Volatility of Interest Rates. I doubt the book refers to equity option pricing because you would not be comparing apples to apples. Instead, I think they refer to the binomial model using the observed price of a bond with an embedded option.

I see now that they were talking about options on the actual corp bonds not on their common. I got this from Stalla.

Red Wrote: ------------------------------------------------------- > It is mentioned in the text that you can derive > implied volatility from observed prices in > interest rate derivatives and option pricing > models. This is mentioned in Reading 56 - Term > Structure and Volatility of Interest Rates. This makes more sense as you really can’t relate the interest rate vol on an IRD from the commons.

Red Wrote: ------------------------------------------------------- > It is mentioned in the text that you can derive > implied volatility from observed prices in > interest rate derivatives and option pricing > models. This is mentioned in Reading 56 - Term > Structure and Volatility of Interest Rates. > That’s absolutely right - you can get implied vol of interest rates from interest rate derivatives. > I doubt the book refers to equity option pricing > because you would not be comparing apples to > apples. Instead, I think they refer to the > binomial model using the observed price of a bond > with an embedded option. Anyway, “an equity option has the same price under B-S regardless of interest rate vol” is kind of an interesting thing to get your head around.