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An options-based analysis of emerging market exchange rate expectations: Brazil's Real Plan, 1994-1999

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  • Campa, Jose M.
  • Chang, P. H. Kevin
  • Refalo, James F.

Abstract

This Paper uses currency option data from the BMF, the Commodities and Futures exchange in Sao Paulo, Brazil, to investigate market expectations on the Brazilian Real-US dollar exchange rate from October 1994 through to March 1999. Using options data, we derive implied probability density functions (PDF) for expected future exchange rates and thus measures of the credibility of the ‘crawling peg’ and target zone (‘maxiband’) regimes governing the exchange rate. Since we do not impose an exchange rate model, our analysis is based on either the risk-neutral PDF or arbitrage-based tests of target zones. The Paper, one of the first to use options data from an emerging market, finds that target zone credibility was poor prior to February 1996, improved afterwards through September 1997 and later started to worsen again. The market anticipated periodic band adjustments, and estimated distributions are very sensitive to political and economic news affecting the credibility of the regime. We also test whether devaluation intensities estimated from these option prices can be explained by standard macroeconomic factors.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 69 (2002)
Issue (Month): 1 (October)
Pages: 227-253

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Handle: RePEc:eee:deveco:v:69:y:2002:i:1:p:227-253

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Web page: http://www.elsevier.com/locate/devec

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Cited by:
  1. Maltritz, Dominik & Eichler, Stefan, 2010. "Currency crisis prediction using ADR market data: An options-based approach," International Journal of Forecasting, Elsevier, vol. 26(4), pages 858-884, October.
  2. Peter Christoffersen & Kris Jacobs & Bo Young Chang, 2011. "Forecasting with Option Implied Information," CREATES Research Papers 2011-46, School of Economics and Management, University of Aarhus.
  3. Bernardo Guimaraes, 2008. "Vulnerability of currency pegs: evidence from Brazil," LSE Research Online Documents on Economics 4909, London School of Economics and Political Science, LSE Library.

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