Option-Implied Libor Rate Expectations Across Currencies

47 Pages Posted: 18 Oct 2016

See all articles by Nick Gebbia

Nick Gebbia

Board of Governors of the Federal Reserve System

Date Written: 2016-10-13

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

JEL Classification: C14, E43, G13

Suggested Citation

Gebbia, Nick, Option-Implied Libor Rate Expectations Across Currencies (2016-10-13). FRB International Finance Discussion Paper No. 1182. Available at SSRN: https://ssrn.com/abstract=2854046 or http://dx.doi.org/10.17016/IFDP.2016.1182

Nick Gebbia (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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