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Using Eurodollar futures options: gauging the market's view of interest rate movements

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  • Peter A. Abken

Abstract

Investors and analysts frequently use financial market prices in their attempts to divine market expectations--a difficult exercise because of the myriad influences on financial market prices. This article focuses on shifts in market outlook regarding the direction of interest rate movements since 1988 as well as market reaction to specific events influencing interest rate changes in the short run--namely, Federal Reserve monetary policy and its periodic Federal Open Market Committee meetings. ; The discussion examines the Eurodollar futures options traded at the Chicago Mercantile Exchange and explains how to infer the implied skewness of interest rates--a measure that gauges the direction and magnitude of their movements--from these options. In particular, this article shows how the skewness of the distribution of a short-term interest rate, LIBOR, can be inferred from market prices. ; The basic conclusion of this article is that a marked shift in market outlook on interest rate movements occurred in late 1992. The analysis finds that during 1993 and 1994, skewness was manifest by a premium in the prices of Eurodollar futures puts, which offer protection against rising interest rates, compared with those of Eurodollar futures calls. The findings also indicate, though, that the Eurodollar futures options prices are too noisy to detect changes in the markets' view of future short-term interest rate movements following FOMC meetings.

Suggested Citation

  • Peter A. Abken, 1995. "Using Eurodollar futures options: gauging the market's view of interest rate movements," Economic Review, Federal Reserve Bank of Atlanta, vol. 80(Mar), pages 10-30.
  • Handle: RePEc:fip:fedaer:y:1995:i:mar:p:10-30:n:v.80no.2
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    Cited by:

    1. Campa, Jose Manuel & Chang, P. H. Kevin, 1998. "The forecasting ability of correlations implied in foreign exchange options," Journal of International Money and Finance, Elsevier, vol. 17(6), pages 855-880, December.
    2. Alessandro Beber & Luca Erzegovesi, 1999. "Distribuzioni di probabilità implicite nei prezzi delle opzioni," Alea Tech Reports 008, Department of Computer and Management Sciences, University of Trento, Italy, revised 14 Jun 2008.
    3. William R. Emmons & Aeimit K. Lakdawala & Christopher J. Neely, 2006. "What are the odds? option-based forecasts of FOMC target changes," Review, Federal Reserve Bank of St. Louis, vol. 88(Nov), pages 543-562.
    4. Jose M. Campa & P.H. Kevin Chang & Robert L. Reider, 1997. "Implied Exchange Rate Distributions: Evidence from OTC Option Markets," NBER Working Papers 6179, National Bureau of Economic Research, Inc.
    5. José Manuel Campa & P.H. Kevin Chang & James F. Refalo, 1999. "An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1997," Working Papers 99-08, New York University, Leonard N. Stern School of Business, Department of Economics.
    6. Campa, Jose M. & Chang, P. H. Kevin & Reider, Robert L., 1998. "Implied exchange rate distributions: evidence from OTC option markets1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 117-160, February.

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