Tag Archives: derivatives

Life below zero – the impact of negative rates on derivatives activity

James Purchase and Nick Constantine.

In 1995, Fischer Black, an economist whose ground-breaking work in financial theory helped revolutionise options trading, confidently stated that “the nominal short rate cannot be negative.”  Twenty years later this assumption looks questionable: one quarter of world GDP now comes from countries with negative central bank policy rates.  Practitioners have been forced to update their models accordingly, in many cases introducing greater complexity.  But this shift is not just academic.  Models allowing for a wider distribution of future rates require market participants to hedge against greater uncertainty.  We argue that this hedging contributed to the volatility in global rates in early 2015, but that derivatives can also play an important role in facilitating monetary policy transmission at negative rates.

Continue reading

Comments Off on Life below zero – the impact of negative rates on derivatives activity

Filed under Financial Markets, Market Infrastructure, Monetary Policy, New Methodologies

Mean and modal Bank Rate expectations

Will Dison and David Elliott.

Financial market prices provide information about market participants’ Bank Rate expectations. But central expectations can be measured in different ways. Mean expectations, derived from forward interest rates, represent the average of the range of possible outcomes, weighted by their perceived probabilities. On the other hand, modal expectations, which can be estimated from interest rate options, represent the perceived single most likely outcome. Currently, these market-implied mean and modal expectations for the path of Bank Rate over the coming few years differ starkly, with the mode lying well below the mean. In this post we argue that this divergence primarily reflects the proximity of the effective lower bound to nominal interest rates.

Continue reading

Comments Off on Mean and modal Bank Rate expectations

Filed under Financial Markets, Macroeconomics, Monetary Policy