Central bank research hub - Papers by Aquiles Rocha de Farias
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Research hub papers by author Aquiles Rocha de FariasenEstimating Relative Risk Aversion, Risk-Neutral and Real-World Densities using Brazilian Real Currency Options
http://www.bcb.gov.br/pec/wps/ingl/wps269.pdf
Central Bank of Brazil Working Papers by José Renato Haas Ornelas, José Santiago Fajardo Barbachan and Aquiles Rocha de FariasEstimating Relative Risk Aversion, Risk-Neutral and Real-World Densities using Brazilian Real Currency Options2012-03-22T06:21:00ZBuilding Risk-Neutral Densities (RND) from options data can provide market-implied expectations about the future behavior of a financial variable. This paper uses the Liu et all (2007) approach to estimate the option-implied risk-neutral densities from the Brazilian Real/US Dollar exchange rate distribution. We then compare the RND with actual exchange rates, on a monthly basis, in order to estimate the relative risk-aversion of investors and also obtain a real-world density for the exchange rate. We are the first to calculate relative risk-aversion and the option-implied real world Density for an emerging market currency. Our empirical application uses a sample of exchange-traded Brazilian Real currency options from 1999 to 2011. The RND is estimated using a Mixture of Two Log-Normals distribution and then the real-world density is obtained by means of the Liu et al. (2007) parametric risk-transformations. Our estimated value of the relative risk aversion parameter is around 2.7, which is in line with other articles that have estimated this parameter for the Brazilian Economy. Our out-of-sample evaluation results showed that the RND has some ability to forecast the Brazilian Real exchange rate. However, when we incorporate the risk aversion into RND in order to obtain a Real-world density, the outof- sample performance improves substantially. Therefore, we would suggest not using the "pure" RND, but rather taking into account risk aversion in order to forecast the Brazilian Real exchange rate.Estimating Relative Risk Aversion, Risk-Neutral and Real-World Densities using Brazilian Real Currency OptionsAbstracthttp://www.bcb.gov.br/pec/wps/port/wp269.asp?idiom=IFull texthttp://www.bcb.gov.br/pec/wps/ingl/wps269.pdfJosé Renato Haas OrnelasAquiles Rocha de FariasJosé Santiago Fajardo BarbachanJosé Renato Haas Ornelas, José Santiago Fajardo Barbachan and Aquiles Rocha de Farias2012-03Central Bank of Brazil Working PapersC13C53F31G17