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September 2016 issue
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Ramos-Francia
Altavilla, Giannone, Lenza
Bluwstein, Canova
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Options-Implied Probability Density Functions for Real Interest Rates

by Jonathan H. Wright
Johns Hopkins University

Abstract

This paper constructs options-implied probability density functions for real interest rates. These use options on TIPS, which were launched in 2009. Data availability limits us to studying short-maturity probability density functions for intermediate- to long-term TIPS yields. The PDFs imply high uncertainty about real rates. I also estimate empirical pricing kernels using these option prices along with time-series models fitted to real interest rates. The empirical pricing kernel implies that investors have high marginal utility in states of the world with high real rates.

JEL Codes: C58, E43, G12.

 
Full article (PDF, 21 pages, 619 kb)

Discussion by Eric T. Swanson