## Duration volatility risk premia

*The analysis of this post has been updated on June 22, 2023*

Duration volatility risk premium means compensation for bearing return volatility risk of an interest rate swap (IRS) contract. It is the scaled difference between swaption-implied and realized volatility of swap rates’ changes. Historically, these premia have been stationary around positive long-term averages, with episodes of negative values. Unlike in equity, simple duration volatility risk premia have not been significant predictors of subsequent IRS returns. However, they have helped predict idiosyncratic IRS returns in non-USD markets.

Moreover, two derived concepts of volatility risk premia hold promise for trading strategies. [1] Term spreads are the differences between volatility risk premia for longer-maturity and shorter-maturity IRS contracts and are related to the credibility of a monetary policy regime. Historically, term spreads have been significant predictors of returns on curve positions. [2] Maturity spreads are the differences between volatility risk premia of longer- and shorter-maturity options and should be indicative of a fear of risk escalation, which affects mainly fixed receivers. Indeed, maturity spreads have been positively and significantly related to subsequent fixed-rate receiver returns. These premia are best combined with fundamental indicators of the related risks to give valid signals for fixed-income positions.