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.
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 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 climb well before the vote, rather than spiking on election day. This increase tends to be “convex”, meaning that the closer and more competitive the race, the faster volatility rises.
“As election day nears, the market’s focus shifts to jump risk, as uncertainty grows around a binary outcome. In short, Brazil’s electoral volatility is driven by a combination of anticipation, convexity, and jump risk,” Mandel said.
Looking at past races, Mandel emphasized that each election cycle shows its own dynamic. “In 2006 and 2010, for instance, implied real volatility followed a choppy, sideways pattern until about five months before the vote, when it spiked briefly and then cooled,” he recalled.
At the time, Brazil was transitioning from Luiz Inácio Lula da Silva to himself in 2006 and from Lula to Dilma Rousseff in 2010. These transitions carried some event risk, but with limited economic-policy uncertainty. “As a result, option markets priced in low levels of anticipation and jump risk in the three to six months before the vote,” he said.
In contrast, the 2018 race was perceived as a more significant regime shift, with Jair Bolsonaro representing a break from previous administrations. As in other cycles, volatility began to rise six months before the election, but then accelerated sharply—almost all the way to the first round—as polls tightened and jump risk surged, peaking at 2.5 standard deviations.
“In 2022, with two well-known candidates, the rise in implied volatility was less convex but more persistent than in 2018. Still, it reached similar levels on election day as polls narrowed,” he said.
Mandel also noted that the recent announcement of Senator Flávio Bolsonaro (Liberal Party, Rio de Janeiro) as a pre-candidate for the presidency increased political uncertainty and sparked speculation that electoral market volatility may already be underway.
“Even so, current levels of implied volatility remain low. With more than ten months to go before the election, we are still far from the typical three-to-six-month window when volatility tends to rise. Once that window opens, patterns from recent cycles suggest sharp convexity and growing jump risk if the race looks close,” he concluded.