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Option-Implied Libor Rate Expectations across Currencies

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  • Nick Gebbia

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.

Suggested Citation

  • Nick Gebbia, 2016. "Option-Implied Libor Rate Expectations across Currencies," International Finance Discussion Papers 1182, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1182
    DOI: 10.17016/IFDP.2016.1182
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Options; Futures; Libor; Pdf; Distribution; Moments; Granger causality;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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