Recovering Risk-Neutral Densities from Brazilian Interest Rate Options

Brazilian Finance Review, Vol. 9, No. 1, pp. 9-26, 2011

14 Pages Posted: 1 May 2009 Last revised: 20 Jun 2011

See all articles by Jose Renato Haas Ornelas

Jose Renato Haas Ornelas

Banco Central do Brasil

Marcelo Yoshio Takami

Government of the Federative Republic of Brazil - Central Bank of Brazil

Date Written: April 26, 2009

Abstract

Building Risk-Neutral Density (RND) from options data is one useful form of 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 during the our sample period. The shape of the family of log-normal distributions seems to fit well to the mean-reversal dynamics of Brazilian interest rates. We also calculate 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.

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

JEL Classification: C13, C16, E47, E52, G12, G13, G17

Suggested Citation

Ornelas, Jose Renato Haas and Takami, Marcelo Yoshio, Recovering Risk-Neutral Densities from Brazilian Interest Rate Options (April 26, 2009). Brazilian Finance Review, Vol. 9, No. 1, pp. 9-26, 2011 . Available at SSRN: https://ssrn.com/abstract=1395503

Jose Renato Haas Ornelas (Contact Author)

Banco Central do Brasil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distrito Federal 70074-900
Brazil

HOME PAGE: http://www.bcb.gov.br

Marcelo Yoshio Takami

Government of the Federative Republic of Brazil - Central Bank of Brazil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

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