The Economics of Options-Implied Inflation Probability Density Functions
Yuriy Kitsul and
Jonathan Wright
No 18195, NBER Working Papers from National Bureau of Economic Research, Inc
Abstract:
Recently a market in options based on CPI 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 pdfs respond to news announcements, and find that the implied odds of deflation are sensitive to certain macroeconomic news releases. We compare the option-implied probability densities with those obtained by time series methods, and use this information to construct empirical pricing kernels. 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.
JEL-codes: C22 E31 E44 G12 (search for similar items in EconPapers)
Date: 2012-06
New Economics Papers: this item is included in nep-upt
Note: ME
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Citations: View citations in EconPapers (8)
Published as "The Economics of Options-Implied Inflation Probability Density Functions," Journal of Financial Economics, vol. 110, no. 3, pp. 696-711.
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Related works:
Journal Article: The economics of options-implied inflation probability density functions (2013) 
Working Paper: The Economics of Options-Implied Inflation Probability Density Functions (2012) 
Working Paper: The Economics of Options-Implied Inflation Probability Density Functions (2012) 
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