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An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1999

Author

Listed:
  • José 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 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.

Suggested Citation

  • José M. Campa & P.H. Kevin Chang & James F. Refalo, 2000. "An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil's Real Plan, 1994-1999," Working Papers wp2000_0006, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2000_0006
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    Cited by:

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    2. 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.
    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. 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.
    5. 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.
    6. Bernardo Guimaraes, 2005. "Market Expectations and Currency Crises: Theory and Empirics," 2005 Meeting Papers 174, Society for Economic Dynamics.
    7. Bernardo Guimaraes, 2008. "Vulnerability of Currency Pegs: Evidence from Brazil," CEP Discussion Papers dp0871, Centre for Economic Performance, LSE.
    8. Değerli, Ahmet & Fendoğlu, Salih, 2015. "Reserve option mechanism as a stabilizing policy tool: Evidence from exchange rate expectations," International Review of Economics & Finance, Elsevier, vol. 35(C), pages 166-179.
    9. Nguyen Quang My & Mustafa Sayim, 2016. "The Impact of Economic Factors on the Foreign Exchange Rates between USA and Four Big Emerging Countries: China, India, Brazil and Mexico," International Finance and Banking, Macrothink Institute, vol. 3(1), pages 11-43, June.

    More about this item

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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