A1634
Title: Treating inflation targeting as a natural option formula
Authors: Yedidya Rabinovitz - University of Warsaw (Poland) [presenting]
Abstract: Three novel analytical option formulas are developed that measure inflation given a central bank has an inflation-targeting policy. To define the option function, the inflation targeting rate is stated as a natural option, considering this condition is a natural experiment. Instead of measuring the dynamics via the risk-neutral or arbitrage-free market valuation, this option formula proposes the quantity theory of money as the underlying macroeconomic dynamics of prices, given the elements are independent of risk preferences. In the same manner, the quantity theory of money is proven to be a martingale. The methodology has two steps; in the first step, the pricing formula is derived by the multidimensional Its lemma; in the second step, when long memory exists, the multi-fractional multidimensional formulas are presented for a constant H and non-constant h. Hence, a new method of evaluating a natural experiment as an option is formed.
