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An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1997

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

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-U.S. dollar exchange rate from October 1994 through July 1997. 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, but improved afterwards. The market anticipated periodic band adjustments, but over time developed greater confidence in the Real. We also test whether devaluation intensities estimated from these option prices can be explained by standard macroeconomic factors.

Suggested Citation

  • Jose M. 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," NBER Working Papers 6929, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:6929
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    Cited by:

    1. Ting‐Heng Chu & Steve Swidler, 2002. "Forecasting Emerging Market Exchange Rates from Foreign Equity Options," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 25(3), pages 353-366, September.
    2. Carvalho, Augusto & Guimaraes, Bernardo, 2018. "State-controlled companies and political risk: Evidence from the 2014 Brazilian election," Journal of Public Economics, Elsevier, vol. 159(C), pages 66-78.
    3. Datta, Deepa Dhume & Londono, Juan M. & Ross, Landon J., 2017. "Generating options-implied probability densities to understand oil market events," Energy Economics, Elsevier, vol. 64(C), pages 440-457.
    4. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 581-656, Elsevier.
    5. Yoel Hecht & Helena Pompushko, 2005. "Normality, Modal Risk Level, and Exchange-Rate Jumps," Bank of Israel Working Papers 2005.01b, Bank of Israel.
    6. Naszódi, Anna, 2002. "A sávos árfolyamú deviza megközelítése opciók segítségével [The option-based description of the exchange rate in a target-zone system]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(1), pages 25-44.
    7. Naszódi, Anna, 2004. "A sáveltolás árfolyamhatásának vizsgálata opciós modell keretei között [Target-zone rearrangement and exchange-rate behaviour in an options-based model]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(7), pages 638-658.
    8. Yoshino, Joe Akira, 2003. "Market Risk and Volatility in the Brazilian Stock Market," Journal of Applied Economics, Universidad del CEMA, vol. 6(2), pages 1-19, November.
    9. José Renato Haas Ornelas & Marcelo Yoshio Takami, 2011. "Recovering Risk-Neutral Densities from Brazilian Interest Rate Options," Brazilian Review of Finance, Brazilian Society of Finance, vol. 9(1), pages 9-26.

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    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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