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Investors' and Central Bank's Uncertainty Embedded in Index Options

Listed author(s):
  • Alexander David
  • Pietro Veronesi
Registered author(s):

    Shocks to equity options' ATM implied volatility (ATMIV) are followed by persistently lower short-term rates. Shocks to the ratio of OTM puts' over OTM calls' implied volatilities (P/C) are followed by persistently higher rates. The stock's and Treasury-bond's ATMIV indices, which measure market and policy uncertainty, are counter-cyclical while the P/C index, which measures downside risk, is pro-cyclical. An equilibrium model where investors and the central bank learn about composite regimes on economic and policy variables explains these options' dynamics, linking them to a learning-based, forward-looking Taylor rule. The model produces several predictions on the relation between options, monetary policy variables, and beliefs that find support in the data.

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    File URL: http://www.nber.org/papers/w16764.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16764.

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    Date of creation: Feb 2011
    Publication status: published as Investors' and Central Bank's Uncertainty Embedded in Index Options Alexander David University of Calgary Pietro Veronesi Rev. Financ. Stud. (2014) doi: 10.1093/rfs/hhu024
    Handle: RePEc:nbr:nberwo:16764
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