Recovering Risk-Neutral Densities from Brazilian Interest Rate Options

Authors

  • José Renato Haas Ornelas Banco Central do Brasil
  • Marcelo Yoshio Takami Banco Central do Brasil

DOI:

https://doi.org/10.12660/rbfin.v9n1.2011.2761

Keywords:

Risk-Neutral Density, Interest Rate Options, Generalized Beta, Mixture of Log-Normals

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.

Author Biographies

José Renato Haas Ornelas, Banco Central do Brasil

Central Bank of Brazil, Executive Office for Risk Management

Marcelo Yoshio Takami, Banco Central do Brasil

Central Bank of Brazil, Executive Office for Risk Management

Published

04-04-2011

Issue

Section

Articles