Weekly Commentary on Future Asset Values

Updated with data through March 20, 2014

Latest Report

March 20, 2014 [PDF]


Commentary

The S&P 500 was down -30 basis points over the past two weeks. Options trading on the S&P 500 index was strong. The average CCAR bank price rose 260 basis points and the average insurance company price fell -70 basis points. Equity market related RNPD standard deviations (tail risks) generally rose and RNPD skews ticked lower (more negative). These measures do NOT incorporate stress test related information. We intend to follow up with separate analysis of RNPD CCAR reactions.

This time period DOES include market reaction to recent FOMC decisions and guidance. Our standard reports of RNPDs derived from inflation caps and floors show only small changes in the tails. In particular, the reports show the risk neutral probability of deflation changing very little.

We also looked more carefully at risk neutral probabilities in the middle of the distribution. Specifically, we examined changes in risk neutral probabilities at 1%, 2%, and 3% outcomes. The chart below presents the time series of risk neutral probabilities for these outcomes over the subsequent 2 years.

Chart 1

Large chart

We point out the interesting changes from March 17th to March 19th. The risk neutral probability of a 1% inflation rate over the next two years rose 345 basis points while the probabilities of 2% and 3% inflation fell 120 and 277 basis points respectively. For more information on the methodology for making these estimations see Kitsul and Wright.1

Banks & Insurance Companies
Options trading was also relatively brisk for the insurance companies we follow. Volumes were about average in the broader CCAR universe of banks. RNPD standard deviations and skews were mixed.

Banks with above average and increasing trading volume were BK, KEY, and FITB. Insurance companies with above average and increasing trading volume were HIG, LNC, and MET.

Additional Notes:

  • Shares of KEY rallied 5.3%. The RNPD skew derived from options on KEY share became less negative. (See KEY report.)
  • The behavior of FITB shares and its RNPD was similar to that of KEY. The share price rose 4.8% while its RNPD standard deviation and skew fell. This generally the short term relationship we observe between RNPD skew and price. (See FITB report.)

Chart 2

Large chart

  • Despite the volume, RNPDs were relatively unchanged for the insurance firms listed above. (See detail reports.)
  • AMP and PFG skew changes were large but occurred on very light trading. (See AMP and PFG reports.)

Other Commodity Markets
With the exception of wheat, spot prices in the other commodity markets we follow generally fell over the past two weeks. Corn fell -1.8%, gold fell -1.6%, WTI crude fell -2.0%, and the real estate ETF fell -2.1%. The dollar was stronger. Options trading volumes were light. Consistent with the direction of spot prices, RNPD standard deviations rose slightly.

Additional notes:

  • Trading in options on wheat futures was active. The RNPD for wheat shifted noticeably from two weeks ago. Wheat prices rose 8.4% and tail risks in as measured by RNPD standard deviation increased by 240 basis points. RNPD skews for all of the grains remain positive. (See corn, wheat, and soybean reports.)

Chart 3

Large chart

  • The RNPD standard deviation derived from options on cattle futures continues to increase. The RNPD skew is negative. (See cattle report.)
  • The RNPD skews derived from options on soybeans, gold, and WTI crude, are at the highest levels we have measured in the past 20 two week periods. (See soybeans, gold and oil reports.)

Endnote

1 Kitsul, Yuriy and Jonathan H. Wright (2012): The Economics of Option-implied Inflation Probability Density Functions, NBER Working Paper 18195. We note that K-W have updated their methodology in the more recent version of the paper appearing the Journal of Financial Economics (2013).


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