EconPapers    
Economics at your fingertips  
 

The economics of options-implied inflation probability density functions

Yuriy Kitsul and Jonathan H. Wright

Journal of Financial Economics, 2013, vol. 110, issue 3, 696-711

Abstract: Recently a market in options based on consumer price index 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 probability density functions respond to news announcements and find that the implied odds of deflation are sensitive to certain macroeconomic news releases. We also estimate empirical pricing kernels using these option prices along with time series models fitted to inflation. 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.

Keywords: Inflation; Floors and caps; Derivatives; Forward martingale measure; Physical measure (search for similar items in EconPapers)
JEL-codes: C22 E31 E44 G12 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations View citations in EconPapers (16) Track citations by RSS feed

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304405X13002274
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:110:y:2013:i:3:p:696-711

Access Statistics for this article

Journal of Financial Economics is currently edited by G. William Schwert

More articles in Journal of Financial Economics from Elsevier
Series data maintained by Dana Niculescu ().

 
Page updated 2017-09-29
Handle: RePEc:eee:jfinec:v:110:y:2013:i:3:p:696-711