Researchers use option prices to gauge ZLB risk – San Fran Fed

san francisco fed

Interest rate derivates may be helpful to estimate the risks of hitting the zero lower bound (ZLB) at some point in the future, an economic letter published by Federal Reserve Bank of San Francisco shows.

Michael Bauer and Thomas Mertens use prices of Eurodollar options to estimate the probability that future short-term interest rates will hit the ZLB.

They use Libor as the key short-term rate due to the higher trading activity in Eurodollar options, and conclude that if Libor is at 0.75%, the

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