Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 621: New Techniques to Extract Market Expectations from Financial Instruments

Paul Söderlind () and Lars E.O. Svensson ()
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Paul Söderlind: Department of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, Box 6501 , S-113 83 Stockholm
Lars E.O. Svensson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden

Abstract: This paper is a selective survey of new or recent methods to extract information about market expectations from asset prices for monetary policy purposes. We shall discuss methods to extract market expectations of future interest rates, exchange rates and inflation rates. Traditionally, interest rates and forward exchange rates have been used to extract expected means of future interest rates, exchange rates and inflation. More recently, these methods have been refined to rely on implied forward exchange rates, so as to extract expected future time-paths of interest rates, exchange rates and inflatione rates. Very recently, methods have been designed to extract not only means but the whole (risk neutral) probability distribution of future interest rates and exchange rates from a set of option prices. More developed and deeper financial markets, increased international financial integration, and new financial instruments are preconditions for these methods. The survey also reports on available instruments and their suitability for different purposes and methods.

Keywords: Market expectations; interest rates; exchange rates; inflation rates; asset prices

JEL-codes: E43; E52

47 pages, October 30, 1997

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