Option-Based Risk Aversion Indicators for Predicting Currency Crises in Emerging Markets

Jaqueline Marins

No 515, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: Currency crises generally coincide with periods in which risk aversion increases. Option prices can be used to extract information about risk aversion in a forward-looking way. With this advantage in mind, this paper tests whether some option-based risk aversion indicators can improve currency crises prediction. The sample data refer to 14 emerging currencies from January 2007 to July 2018, covering the Subprime and the European crises. I use a probit model for panel data of these countries to estimate the probability of currency crises in a 12-month horizon. The results show option-based risk aversion indicators have the expected positive sign and are statistically significant to predict those crises. When added to traditional control variables used in the probit model, they generally improve quality and predictive power of the regressions.

Date: 2020-01
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