Using Eurodollar futures options: gauging the market's view of interest rate movements
Abstract: Investors and analysts frequently use financial market prices in their attempts to divine market expectations--a difficult exercise because of the myriad influences on financial market prices. This article focuses on shifts in market outlook regarding the direction of interest rate movements since 1988 as well as market reaction to specific events influencing interest rate changes in the short run--namely, Federal Reserve monetary policy and its periodic Federal Open Market Committee meetings. ; The discussion examines the Eurodollar futures options traded at the Chicago Mercantile Exchange and explains how to infer the implied skewness of interest rates--a measure that gauges the direction and magnitude of their movements--from these options. In particular, this article shows how the skewness of the distribution of a short-term interest rate, LIBOR, can be inferred from market prices. ; The basic conclusion of this article is that a marked shift in market outlook on interest rate movements occurred in late 1992. The analysis finds that during 1993 and 1994, skewness was manifest by a premium in the prices of Eurodollar futures puts, which offer protection against rising interest rates, compared with those of Eurodollar futures calls. The findings also indicate, though, that the Eurodollar futures options prices are too noisy to detect changes in the markets' view of future short-term interest rate movements following FOMC meetings.
Provider: Federal Reserve Bank of Atlanta
Part of Series: Economic Review
Publication Date: 1995