Using options prices to measure financial risk : The Kansas City Fed Policy Rate Skew

The takeaway

The Kansas City Fed uses options prices to measure how financial markets perceive the balance of risks for future short-term interest rates: a.k.a., the KC Policy Rate Skew.

The data

Options are publicly traded financial instruments that reflect expectations about future economic conditions. The Kansas City Fed uses options prices to create their daily index of how financial markets perceive the balance of risks, or “skew,” to short-term U.S. interest rates one year in the future. Our FRED graph above shows the value of this “KC PRS” index over the past five years, although daily data in FRED are available as far back as April 3, 1989.

FYI, the KC PRS is constructed with the same methodology as the Chicago Board Options Exchange Skew Index (Cboe Skew) on the Chicago Mercantile Exchange’s options data.

The interpretation

Although the ups and downs of the KC PRS don’t match the expansions and contractions of the business cycle, research from the KC Fed indicates that this index tends to lead (i.e., occur ahead of) the cyclical patterns in interest rates

A positive value of the KC PRS index indicates financial markets believe interest rates are more likely to end up higher than projected, whereas a negative value suggests rates could end up lower than projected. Between mid-September 2022 and late March 2026, the index generally showed values below zero. Between early 2026 and the time of this writing, it has averaged values above zero.

How this graph was created: Go to FRED and search for “Kansas City Fed’s Policy Rate Skew.” To plot the data over the past five years, click on the “5Y” link above the graph’s canvas.

Suggested by Diego Mendez-Carbajo.