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|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.econ.jhu.edu
More information through EDIRC
References listed on IDEAS
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.:
- 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,"
Federal Reserve Bank of San Francisco, issue Jan.
- 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, 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.
- 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-.
- 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.
- 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.
- 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.
- Neil Shephard & Yashurio Omori, 2004. "Stochastic volatility with leverage: fast likelihood inference," Economics Series Working Papers 2004-FE-16, University of Oxford, Department of Economics.
- 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.
- 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.).
- Ray Fair, 2003.
"Events that Shook the Market,"
Yale School of Management Working Papers
ysm307, Yale School of Management.
- 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.
- 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.
- 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.).
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)The email address of this maintainer does not seem to be valid anymore. Please ask None to update the entry or send us the correct address
If references are entirely missing, you can add them using this form.