Updated with data through November 28, 2013
November 28, 2013 [PDF]
Banks & Insurance Companies
Banks and insurance company stocks continued to rally over the past two weeks outperforming the S&P 500 (+0.9%) again. The average CCAR bank rose 3%. The average price of the five insurance companies we follow rose 1.4%.
Other Commodity Markets
Trading levels in options on the other commodity markets we follow were light last week. The exception was trading in options on exchange rate futures. We continued to see strong very high levels of activity in the Dollar-Pound market.
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Large changes in asset values or commodities prices can be associated with significant changes in economic output and price and financial stability. For that reason, policymakers seek to monitor market concerns about extreme movements—so-called tail events—in key asset and commodities markets. The prices of options to buy (“call options”) or sell (“put options”) assets or commodities in the future at specified prices (“strike prices”) provide valuable information about potential tail events. The prices of call and put options with differing strike prices can be used to estimate a probability density function of the payoff of the underlying asset or commodity.
In this report, we use options prices to produce what are known as “risk-neutral probability density functions” (RNPDs) for future asset and commodity values. Interpreting RNPDs can be subtle, because they combine both investors’ expectations of the future price of the traded asset or commodity and the compensation they received for taking on related aggregate economic risks. The changes over time in RNPDs that we show reflect changes to both of these components, and decomposing the change into the constituent parts is not possible without making additional strong assumptions. Nonetheless, we regard the RNPDs shown here as valuable barometers of financial market sensitivity to possible extreme movements in the prices of key assets and commodities.
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The exhibits contained in this report show density functions at three different points in time, allowing viewers to see how risk-neutral expectations of market participants have evolved over time. Specifically, we think it isuseful to examine the following characteristics within each exhibit and note how they have changed over time: