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This question is a bit confused, but please bear with me. Now and then I see people use the terminology "price volatility" and "yield volatility" in connection with bond options. I understand the concept of implied volatility for equity options, and I know that option prices are often quoted in terms of their implied volatility.

Is this something similar? Take a Bond options for example. Given a market price in e.g. EUR it is possible (analogues to equity options using Black-Scholes) to find an implied volatility (using Black-76). I guess this is the so called price (bond) volatility.

But when it comes to the so called "yield volatility". I cannot understand how these are implied. I have spent some time on Google trying to find a solid source where I can read more about this, but I can't find it.

Thanks in advance for any assistance!

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1 Answer 1

They are not referring to any implied volatility but actual volatility, i.e. statistical standard deviation. The price volatility is the annualized standard deviation of bond price changes and the yield volatility the annualized standard deviation of bond yield changes. These quantities are usually estimated using a historical estimator. If you have n observations of a quantity X with a sample mean of $\bar{x}$ then its standard deviation is estimated as: $$ \hat{\sigma}_x = \left( \frac{1}{n-1} \sum_{i=1}^{n} (x_i-\bar{x})^2\right)^{\frac{1}{2}}$$ Most frequently, daily closing price/yield observations are used in which case you have to multiply with $\sqrt{N}$ where N are the number of days per year (depending on the day count convention).

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