Abstract
While the Phillips curve appeared quiescent after the Great Financial Crisis (GFC), inflation risk, as gauged from option prices, remained sensitive to employment dynamics. Using Phillips-curve regressions centered on option-implied risk-neutral moments, I show that, in tight labor markets, a fall in the unemployment gap raises the risk that inflation overshoots expectations—even if realized inflation remains stable. In tight labor markets, implied moments convey valuable information, as shown by their ability to anticipate future patterns in inflation break-evens and wage growth. Being risk neutral, option-implied moments embed risk premia, which can make moments particularly informative about developments that matter the most to investors. The usefulness of inflation options in assessing risk, despite their illiquidity, is rooted in reputational incentives that dealers have to disseminate accurate quotes.
Authors
- Sirio Aramonte
JEL codes
- G12
- G14
- G23