Option-Implied Libor Rate Expectations across Currencies

Nick Gebbia

No 1182, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)

Abstract: In this paper, I study risk-neutral probability densities regarding future Libor rates denominated in British pounds, euros, and US dollars as implied by option prices. I apply Breeden and Litzenberger?s (1978) result regarding the relationship between option prices and implied probabilities for the underlying to estimate full probability density functions for future Libor rates. I use these estimates in case studies, detailing the evolution of probabalistic expectations for future Libor rates over the course of several important market events. Next, I compute distributional moments from density functions estimated for fixed horizons and test for Granger causality across the three Libor rate distributions considering their mean, standard deviation, skewness, and kurtosis. I further break these relationships down by various fixed horizon lengths, as well as the slope and curvature in the term structure of moments over different horizons. The results show a rich interconnectedness among these three Libor rates that extends well beyond levels of future mean expectations.

Keywords: Options; Futures; Libor; Pdf; Distribution; Moments; Granger causality (search for similar items in EconPapers)
JEL-codes: C14 E43 G13 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2016-10-13
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgif:1182

DOI: 10.17016/IFDP.2016.1182

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