Measuring Euro-Area Inflation Risk with Options: Market-Implied Distribution and Balance of Risks

Diego Bonelli
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Diego Bonelli: Banco de España

No 2625, Occasional Papers from Banco de España

Abstract: We recover risk-neutral spot distributions of euro-area inflation from caps and floors using two non-normal models — the parametric SABR smile and a nonparametric estimator — benchmarked against a normal model. We construct forward distributions from the spot marginals using a copula. Both non-normal models imply skewed and fat-tailed distributions, while the normal benchmark assigns less probability to extreme outcomes. We summarise the distributions with a balance-of-risks index, which varies sharply over short horizons but shows more limited movement over longer horizons. On matched dates, the option-implied balance of risks is generally lower than the corresponding measure reported by professional forecasters.

Keywords: inflation options; risk-neutral density; SABR; balance of risks; tail risk; euro area (search for similar items in EconPapers)
JEL-codes: C58 E31 E44 G13 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2026-10
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Persistent link: https://EconPapers.repec.org/RePEc:bde:opaper:2625e

DOI: 10.53479/44845

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