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This paper examines implied parameters from options on LIBOR futures. Jump-diffusion models are found to offer superior in-sample and out-of-sample performance when compared to their pure diffusion counterpart. The need to incorporate stochastic jump magnitudes into LIBOR dynamics is also documented. In addition, empirical evidence reveals that the jump component in LIBOR rates is important for pricing their derivatives. Furthermore, variation in jump risk often coincides with Federal Open Market Committee (FOMC) decisions and a small subset of macroeconomic announcements.


NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Banking and Finance. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Banking and Finance, volume 29, issue 10, in 2005.

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