Forward-Looking Monetary Policy Rules and Option-Implied Interest Rate Expectations
Journal of Futures Markets, Vol. 34, No. 4, pp. 346-373, 2014
51 Pages Posted: 25 Mar 2010 Last revised: 19 Dec 2015
Date Written: November 8, 2012
This paper examines the association between option-implied interest rate distributions and macroeconomic expectations in the context of a forward-looking monetary policy rule. We presume that market participants view the policy rule as a guide to the path of future policy rates and price interest rate options in accordance with the policy rule fundamentals. Using data from the UK, we confirm that Libor expectations implied by option prices are consistent with the policy rule variables. The results demonstrate that changes in the distributional form of Libor expectations are strongly associated with changes in the expected inflation and output gaps and financial uncertainty.
Keywords: interest rate expectations, implied probability distributions, forward-looking monetary policy rules, Taylor rules
JEL Classification: E43, E44, E52, E58, G13
Suggested Citation: Suggested Citation