The Statistical Distribution of Short-Term Libor Rates Under Two Monetary Regimes

Abstract:     
The paper presents a statistical analysis of sterling libor interest rates in two monetary regimes: free-floating of sterling prior to ERM-entry, and the recent ERM regime. It is found that short-term libor rates follow a random walk with time-varying volatility and with interest rate changes drawn from a distribution with fat tails, (sic). The nature of interest rate changes is sensitive to monetary regime: interest rate changes in the pre-ERM regime are drawn from a distribution with much faster tails than for the ERM regime.

These statistical characterisations of libor rates are inconsistent with existing models for pricing interest rate and bond options, which assume either that interest rates follow a random walk with constant volatility, or that interest rates are mean-reverting.

JEL Classification: E43, F33, G12

working papers series