IR and Price volatility

Does IR volatility and Price volatility have the same effect on value of call/put option and callable/putable bond?

Interesting question! Probably good topic for thesis research! =) I don’t think its in our curriculum, right?

We know that higher price volatility would increase call and put option prices. My guess is higher IR volatility would also increase call and put option prices, but to a smaller extent. As the curriculum states that “the price of a (European) option on an asset is not very sensitive to the risk-free rate. When the underlying is an interest rate however, there is a strong relationship between the option price and interest rates”

Some Googling also reveal that Scott ( 1993 ) finds that interest rate volatility has little impact on short - term options.

Scott, L.O. 1993, “Pricing Stock Options in a Jump Diffusion Model with Stochastic Volatility and Interest Rates: Applications of Fourier Inversion Methods” University of Georgia