Assessing the compensation for volatility risk implicit in interest rate derivatives

Volatilities implied from interest rate swaptions are used to assess the size and thesign of the compensation for volatility risk, for dollar, euro and pound rates at a dailyfrequency, between October 1998 and August 2006. The measurement of the volatilityrisk premium rests on a simple model according to which variance forecasts are gen-erated under the objective probability measure. Results show that especially betweenSeptember 2001 and mid-2003 dollar implieds were embodying a large - negative -compensation for volatility risk, a component which was smaller in absolute terms -but not relative to the level of the respective implied volatilities - for the other twocurrencies...