Implied Volatility signals Rising Electoral Risk in Brazil

In Brazil, where financial assets typically move in sync, implied exchange rate volatility has become a useful tool for analyzing how markets price in future uncertainty, especially ahead of presidential elections.

A recent study by asset manager Jubarte Capital shows that the volatility of the Brazilian real tends to rise three to six months before elections. As election day approaches, and especially when races are tight, so-called “jump risks” also increase.

“Implied volatility on the real has often been one of the first indicators to respond to electoral risks,” said Benjamin Mandel, head of research at Jubarte Capital.

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He explained that financial literature offers several ways to model how electoral risk is priced into volatility. “The simplest model is anticipation.It assumes a steady increase in volatility as the event nears, and allows for a stronger reaction to bad news than to good news,” Mandel noted.

“Jump intensity,” on the other hand, reflects the probability markets assign to a sudden shock in an asset’s price. It is indeed typically modeled as a time-varying factor. “It has the realistic feature of allowing volatility to rise even before a jump occurs, simply due to rising tension in the electoral race,” he said.

In a typical election year, Mandel pointed out, implied currency volatility begins to