A Note on Monetary Policy with Interest-Rate Contingent Claims as Indicators

Abstract

In this paper, we consider the use of interest rate contingent claims as indicators for the monetary policy. We analyze two approaches: one based on the term structure of zero bonds and another based on interest-rate option derivatives. We show how traditional tools based on the Black framework could be biased to build indicators for monetary policy. In fact, the second method could not be viewed as an alternative approach, but as a complementary approach of the term structure approach. The conduct of monetary policy by central banks could be achieved by using some targets and instruments. By doing that, they need to build indicators. In most case, these indicators are based on interest rates expectations. Two main methods are available to compute these expactations. The Þrst one is to consider the term structure of zero bonds (or interest rates). The second one is more complex and is based on derivatives. Contingent claims could be useful to extract expectations because these assets look forward. In this short note, we present briesy these two approaches and we illustrate the fact that these two approaches are not competitive but complementary. Moreover, the particularity of interest rate contingent claims imply that we have to imagine new speciÞc tools for the second approach. 2 Monetary policy with term structure of zero bonds as indicators The term structure of zero bonds can be used to determine the yield curve and the term structure of forward interest rates. These forward rates can be used as indicators, which contain some informations on interest rates market expectations (Svensson [1994]). So, they can be used to forecast interest rates and we can forecast foreign exchange rates (under the assumption of uncovered interest rates parity) or insation (under the assumption of Fisher relationship). They have even been used to estimate the credibility of EMU.