The term structure of implied volatility

A rising term structural volatility indicates that market participants expect shortterm
implied volatility to rise or that they are willing to pay more for protection
against near-term asset price volatility. Figure 1.20 illustrates a plot of the implied
volatilities of options on a 10-year US dollar swap (swaptions) with option maturities
between one month and 5 years.
Typically, longer-term implied volatilities vary less over time than shorter-term
volatilities on the same asset. Also typically, there are only small differences among
the historical averages of implied volatilities of different maturities. Longer-term volatilities are therefore usually closer to the historical average of implied volatility
than shorter-term implied volatilities.
Shorter-term implied volatilities may be below the longer-term volatilities, giving
rise to an upward-sloping term structure, or above the longer-term volatilities,
giving rise to a downward-sloping term structure. Downward-sloping term structures
typically occur when shocks to the market have abruptly raised volatilities across
the term structure. Short-term volatility responds most readily, since shocks are
usually expected to abate over the course of a year.