DP1556 | New Techniques to Extract Market Expectations from Financial Instruments

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This paper is a selective survey of new or recent methods to extract information about market expectations from asset prices for monetary policy purposes. Traditionally, interest rates and forward exchange rates have been used to extract expected means of future interest rates, exchange rates and inflation. More recently, these methods have been refined to rely on implied forward interest rates, so as to extract expected future time-paths. Very recently, methods have been designed to extract not only the means, but also the whole (risk neutral) probability distribution from a set of option prices.