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Interest rate spreads implicit in options: Spain and Italy against Germany

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  • Bernardino Adao
  • Jorge Barros Luis

Abstract

The options premiums are frequently used to obtain probability density functions (pdfs) for the prices of the underlying assets. When these assets are bank deposits or notional Government bonds it is possible to compute probability measures of future interest rates. Recently, in the literature there have been many papers presenting methods of how to estimate pdfs from options premiums. Nevertheless, as far as we know, the estimation of probabilities of forward interest rate functions is an issue that has not been analysed before. In this paper, we propose such a method, that can be used to study the evolution of the expectations about interest rate convergence. We look at the cases of Spain and Italy against Germany, before the adoption of a single currency, and conclude that the expectations on the short-term interest rates convergence of Spain and Italy vis-a-vis Germany had a somewhat different trajectory, with higher expectations of convergence for Spain.

Suggested Citation

  • Bernardino Adao & Jorge Barros Luis, 2000. "Interest rate spreads implicit in options: Spain and Italy against Germany," Applied Financial Economics, Taylor & Francis Journals, vol. 10(2), pages 155-161.
  • Handle: RePEc:taf:apfiec:v:10:y:2000:i:2:p:155-161
    DOI: 10.1080/096031000331789
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    References listed on IDEAS

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    1. Favero, Carlo A. & Giavazzi, Francesco & Iacone, Fabrizio & Guido Tabellini, 2000. "Extracting information from asset prices: The methodology of EMU calculators," European Economic Review, Elsevier, vol. 44(9), pages 1607-1632, October.
    2. De Grauwe, Paul, 1996. "Forward Interest Rates as Predictors of EMU," CEPR Discussion Papers 1395, C.E.P.R. Discussion Papers.
    3. 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.
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    Cited by:

    1. Driessen, Joost & Perotti, Enrico, 2011. "Confidence building on Euro convergence: Evidence from currency options," Journal of International Money and Finance, Elsevier, vol. 30(3), pages 474-491, April.
    2. Driessen, Joost & Perotti, Enrico C, 2004. "Confidence Building on Euro Conversion: Theory and Evidence from Currency Options," CEPR Discussion Papers 4180, C.E.P.R. Discussion Papers.

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