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

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 01 September 1993

Working Paper No. 16
By Bahram Pesaran and Gary Robinson

We present 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. Our findings indicate that short-term interest rates follow a random walk with time-varying volatility, and increments drawn from a kurtotic distribution. Moreover, we find that the process followed by the short rate is sensitive to the regime: interest rate changes observed in the floating-rate regime are drawn from a distribution with much fatter tails (the Cauchy distribution) than for the ERM regime (t-distribution). This characterisation of the process followed by the short interest rate is inconsistent with existing pricing models for interest-rate-derivative securities, which assume either that short rates follow simple Geometric Brownian Motion, or that they are mean-reverting. 

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