The Economics of Options-Implied Inflation Probability Density Functions
Recently a market in options based on CPI inflation (inflation caps and floors) has emerged in the US. This paper uses quotes on these derivatives to construct probability densities for inflation. We study how these pdfs respond to news announcements, and find that the implied odds of deflation are sensitive to certain macroeconomic news releases. We compare the option-implied probability densities with those obtained by time series methods, and use this information to construct empirical pricing kernels. The options-implied densities assign considerably more mass to extreme inflation outcomes (either deflation or high inflation) than do their time series counterparts. This yields a U-shaped empirical pricing kernel, with investors having high marginal utility in states of the world characterized by either deflation or high inflation.
|Date of creation:||Jul 2012|
|Contact details of provider:|| Postal: 3400 North Charles Street Baltimore, MD 21218|
Web page: http://www.econ.jhu.edu
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Yasuhiro Omori & Siddhartha Chib & Neil Shephard & Jouchi Nakajima, 2004.
"Stochastic Volatility with Leverage: Fast Likelihood Inference,"
CIRJE-F-297, CIRJE, Faculty of Economics, University of Tokyo.
- Yasuhiro Omori & Siddhartha Chib & Neil Shephard & Jouchi Nakajima, 2004. "Stochastic volatility with leverage: fast likelihood inference," Economics Papers 2004-W19, Economics Group, Nuffield College, University of Oxford.
- Jonathan H. Wright, 2011. "What does Monetary Policy do to Long-Term Interest Rates at the Zero Lower Bound?," NBER Working Papers 17154, National Bureau of Economic Research, Inc.
- Ray C. Fair, 2002. "Events That Shook the Market," The Journal of Business, University of Chicago Press, vol. 75(4), pages 713-732, October.
- Ray C. Fair, 2000. "Events that Shook the Market," Yale School of Management Working Papers ysm149, Yale School of Management.
- Ray Fair, 2003. "Events that Shook the Market," Yale School of Management Working Papers ysm307, Yale School of Management.
- Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
- Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2010. "Inflation Expectations and Risk Premiums in an Arbitrage-Free Model of Nominal and Real Bond Yields," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 143-178, 09.
- Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2009. "Inflation expectations and risk premiums in an arbitrage-free model of nominal and real bond yields," Proceedings, Federal Reserve Bank of San Francisco, issue Jan.
- Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2008. "Inflation expectations and risk premiums in an arbitrage-free model of nominal and real bond yields," Working Paper Series 2008-34, Federal Reserve Bank of San Francisco.
- Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2016. "Pricing Deflation Risk with US Treasury Yields," Review of Finance, European Finance Association, vol. 20(3), pages 1107-1152.
- Jens H. E. Christensen & Jose A. Lopez & Glenn D. Rudebusch, 2012. "Pricing deflation risk with U.S. Treasury yields," Working Paper Series 2012-07, Federal Reserve Bank of San Francisco.
- Matthias Fleckenstein & Francis A. Longstaff & Hanno Lustig, 2010. "Why Does the Treasury Issue Tips? The Tips-Treasury Bond Puzzle," NBER Working Papers 16358, National Bureau of Economic Research, Inc.
- Hanno Lustig, 2011. "Why Does the Treasury Issue TIPS? The TIPS-Treasury Bond Puzzle," 2011 Meeting Papers 1443, Society for Economic Dynamics.
- Rosenberg, Joshua V. & Engle, Robert F., 2002. "Empirical pricing kernels," Journal of Financial Economics, Elsevier, vol. 64(3), pages 341-372, June.
- Joshua Rosenberg & Robert F. Engle, 2000. "Empirical Pricing Kernels," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-014, New York University, Leonard N. Stern School of Business-.
- Olesya V. Grishchenko & Joel M. Vanden & Jianing Zhang, 2011. "The information content of the embedded deflation pption in TIPS," Finance and Economics Discussion Series 2011-58, Board of Governors of the Federal Reserve System (U.S.).
- Olesya V. Grishchenko & Jing-zhi Huang, 2012. "Inflation risk premium: evidence from the TIPS market," Finance and Economics Discussion Series 2012-06, Board of Governors of the Federal Reserve System (U.S.). Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:jhu:papers:600. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (None)
If references are entirely missing, you can add them using this form.