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A Volatility Smile-Based Uncertainty Index

José Vicente and Jaqueline Marins

No 502, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: We propose a new uncertainty index based on the discrepancy of the smile of FX options. We show that our index spikes near turbulent periods, forecasts economic activity and its innovations hold a significant and negative equity premium. Unlike other uncertainty indexes, our index is supported by equilibrium models, which relate the difference of options prices across moneyness to uncertainty. Moreover, our index is based on investment decisions, can be easily and continuously updated and is comparable across countries.

New Economics Papers: this item is included in nep-fmk and nep-rmg
Date: 2019-09
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