Monetary Policy and Market Expectations. Evidence from the FTSE 100 Index Option

Abstract

The purpose of this study is to examine market participants’ expectations of future asset prices around monetary policy decision of The Bank of England. This study examines the changes in market participants’ expectations toward possible outcomes in regard of asset prices through examining changes in option implied probability density functions of listed stock options. The study examines changes in the shapes of probability density functions implied by FTSE 100 – index options around monetary policy actions of The Bank of England. The purpose is to examine whether the expectations that market participants assess to future stock prices change systematically around monetary policy actions.

The empirical part of this study examines market expectations around monetary policy decisions of The Bank of England. As a measure of the market expectations of future stock prices the descriptive statistics of implied moments of FTSE 100 – index option contracts are used. More accurately changes in time series data of standard deviation, skewness and kurtosis of option-implied risk-neutral probability density functions are examined around monetary policy actions of The Bank of England. The purpose is to study whether the expectations of future outcome probabilities change systematically around monetary policy decisions. The study uses data spanning from the beginning of June 1997 until the end of May 2011. Altogether this makes the study exploit daily data of 14 years. Altogether the period under examination in this study witnesses Bank of England performing 45 changes in their official bank rate. The findings of the empirical study show that there are systemic changes in some of the estimates of the market.