What moves option-implied bond market expectations?

Abstract

This article examines the impact of macroeconomic news announcements on bond market expectations, as measured by option-implied probability distributions of future bond returns. The results indicate that expected bond market volatilities increase in response to higher-than-expected inflation and unemployment announcements. Furthermore, the asymmetries in bond market expectations are found to be affected mostly by surprises in inflation and economic production figures. In particular, it is found that higher-than-expected inflation announcements cause optionimplied bond return distributions to become more negatively skewed or less positively skewed, implying a shift in market participants' perceptions toward future increases in interest rates. Finally, the results indicate that market expectations of future extreme movements in bond prices are virtually unaffected by macroeconomic news releases. Some evidence is found, however, that suggests that after extreme surprises in inflation announcements market participants attach higher probabilities for extreme movements in bond prices. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:817–843, 2005