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An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil?s Real Plan, 1994-1999

Author

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  • Chang, Kevin
  • Campa, José Manuel
  • Refalo, James F
Abstract
This Paper uses currency option data from the BMF, the Commodities and Futures exchange in Sao Paulo, Brazil, to investigate market expectations on the Brazilian Real-US dollar exchange rate from October 1994 through to March 1999. Using options data, we derive implied probability density functions (PDF) for expected future exchange rates and thus measures of the credibility of the ?crawling peg? and target zone (?maxiband?) regimes governing the exchange rate. Since we do not impose an exchange rate model, our analysis is based on either the risk-neutral PDF or arbitrage-based tests of target zones. The Paper, one of the first to use options data from an emerging market, finds that target zone credibility was poor prior to February 1996, improved afterwards through September 1997 and later started to worsen again. The market anticipated periodic band adjustments, and estimated distributions are very sensitive to political and economic news affecting the credibility of the regime. We also test whether devaluation intensities estimated from these option prices can be explained by standard macroeconomic factors.

Suggested Citation

  • Chang, Kevin & Campa, José Manuel & Refalo, James F, 2000. "An Options-Based Analysis of Emerging Market Exchange Rate Expectations: Brazil?s Real Plan, 1994-1999," CEPR Discussion Papers 2611, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2611
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    Cited by:

    1. Ting‐Heng Chu & Steve Swidler, 2002. "Forecasting Emerging Market Exchange Rates from Foreign Equity Options," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 25(3), pages 353-366, September.
    2. Değerli, Ahmet & Fendoğlu, Salih, 2015. "Reserve option mechanism as a stabilizing policy tool: Evidence from exchange rate expectations," International Review of Economics & Finance, Elsevier, vol. 35(C), pages 166-179.
    3. Carvalho, Augusto & Guimaraes, Bernardo, 2018. "State-controlled companies and political risk: Evidence from the 2014 Brazilian election," Journal of Public Economics, Elsevier, vol. 159(C), pages 66-78.
    4. Datta, Deepa Dhume & Londono, Juan M. & Ross, Landon J., 2017. "Generating options-implied probability densities to understand oil market events," Energy Economics, Elsevier, vol. 64(C), pages 440-457.
    5. Bernardo Guimaraes, 2008. "Vulnerability of Currency Pegs: Evidence from Brazil," CEP Discussion Papers dp0871, Centre for Economic Performance, LSE.
    6. Naszódi, Anna, 2002. "A sávos árfolyamú deviza megközelítése opciók segítségével [The option-based description of the exchange rate in a target-zone system]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(1), pages 25-44.
    7. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 581-656, Elsevier.
    8. Bernardo Guimaraes, 2005. "Market Expectations and Currency Crises: Theory and Empirics," 2005 Meeting Papers 174, Society for Economic Dynamics.
    9. Maltritz, Dominik & Eichler, Stefan, 2010. "Currency crisis prediction using ADR market data: An options-based approach," International Journal of Forecasting, Elsevier, vol. 26(4), pages 858-884, October.
    10. Yoel Hecht & Helena Pompushko, 2005. "Normality, Modal Risk Level, and Exchange-Rate Jumps," Bank of Israel Working Papers 2005.01b, Bank of Israel.
    11. Naszódi, Anna, 2004. "A sáveltolás árfolyamhatásának vizsgálata opciós modell keretei között [Target-zone rearrangement and exchange-rate behaviour in an options-based model]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(7), pages 638-658.
    12. Yoshino, Joe Akira, 2003. "Market Risk and Volatility in the Brazilian Stock Market," Journal of Applied Economics, Universidad del CEMA, vol. 6(2), pages 1-19, November.
    13. José Renato Haas Ornelas & Marcelo Yoshio Takami, 2011. "Recovering Risk-Neutral Densities from Brazilian Interest Rate Options," Brazilian Review of Finance, Brazilian Society of Finance, vol. 9(1), pages 9-26.

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    More about this item

    Keywords

    Exchange rate credibility; Implied distributions; Options;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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