Recovering Risk-Neutral Densities from Brazilian Interest Rate Options

Jose Ornelas and Marcelo Yoshio Takami ()
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Marcelo Yoshio Takami: Banco Central do Brasil

Brazilian Review of Finance, 2011, vol. 9, issue 1, 9-26

Abstract: Building Risk-Neutral Density (RND) from options data is one useful way for extracting market expectations about a financial variable. For a sample of IDI (Brazilian Interbank Deposit Rate Index) options from 1998 to 2009, this paper estimates the option-implied Risk-Neutral Densities for the Brazilian short rate using three methods: Shimko, Mixture of Two Log-Normals and Generalized Beta of Second Kind. Our in-sample goodness-of-fit evaluation shows that the Mixture of Log-Normals method provides better fitting to option’s data than the other two methods. The shape of log-normal distributions seems to fit well to the mean-reversal dynamics of Brazilian interest rates. We have also calculated the RND implied Skewness, showing how it could have provided market early-warning signals of the monetary policy outcomes in 2002 and 2003. Overall, Risk-Neutral Densities implied on IDI options showed to be a useful tool for extracting market expectations about future outcomes of the monetary policy.

Keywords: Risk-Neutral Density; Interest Rate Options; Generalized Beta; Mixture of Log-Normals (search for similar items in EconPapers)
JEL-codes: C13 C16 E47 E52 G12 G13 G17 (search for similar items in EconPapers)
Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:brf:journl:v:9:y:2011:i:1:p:9-26

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