Finance and Financial Management
We investigate whether the same finite dimensional dynamic system spans both interest rates (the yield curve) and interest rate options (the implied volatility surface). We find that the options market exhibits factors independent of the underlying yield curve. While three common factors are adequate to capture the systematic movement of the yield curve, we need three additional factors to capture the movement of the implied volatility surface.
Heidari, Massoud and Wu, Liuren, "Are Interest Rate Derivatives Spanned by the Term Structure of Interest Rates?" (2001). CRIF Working Paper series. 25.