June 1999
Joshua Rosenberg
ABSTRACT
The consistent finding in papers that estimate the interest rate diffusion function is that interest rate volatility
is an increasing function of the spot rate. This paper introduces and implements regression tests of monotonic
diffusion functions using an implied volatility proxy for objective volatility.
Using the case of three-month LIBOR rates, this paper documents that the relationship between interest rate
levels and interest rate volatility is insignificant over the period 1985 through 1998. While rate volatility is
clearly stochastic, it is not characterized by an increasing function (either linear or nonlinear) of rates.
Subject: Investments/Derivatives, Investments/Volatility of Asset Prices, Investments/Econometrics
Rosenberg: (212) 998-0311 jrosenb0@stern.nyu.edu
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