Abstract:We look at whether monetary decisions constitute a significant macro‐finance risk for interest rate options and related implied volatilities. We devise an option‐pricing model based on the dynamics of the Federal Reserve's target rate via a regime‐shift approach modeled as discrete Markov chain capturing the timing of Federal Open Market Committee meetings. We find that the regime‐shift risk is significantly priced and that the downward and stable regimes of the target rate, associated with a decline in real a… Show more
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