In a recent post, my co-author and I showed some charts suggesting that investors have been accepting less compensation for bearing credit risk. This type of risk can be very costly when it materialises, but the probability of that happening is typically very low. A similar risk is inherent in deeply out-of-the-money options. Here too, investors seem to be accepting less compensation for risk.
Continue reading “Bitesize: Premium Delirium II”
Harry Goodacre and Nicholas Vause
Earlier this year, a number of financial market participants, commentators and regulators suggested that investors have been accepting less compensation for bearing given amounts of credit risk. This short post presents two charts in support of that view.
Continue reading “Bitesize: Premium Delirium”
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 “Mean and modal Bank Rate expectations”