Presenter: Ricardo Reis
Affiliation: London School of Economics and Political Science
Date: January 11, 2022
Time: 13:00 GMT
Abstract: The prices of inflation options hold the promise of giving the probability of inflation being either very high or very low at long horizons. To realize this promise requires making three adjustments to option prices: an Arrow-Debreu adjustment, a horizon adjustment, and a risk compensation adjustment. This paper isolates the three adjustments and proposes some ways to implement them. Empirically, we find that the probability of a deflation disaster in the US or the EZ was quite low throughout the 2010s, unlike previous estimates. The probability of a positive inflation disaster has increased sharply in the US from mid-2020 onwards.