LIBOR Reform: Option Pricing for Compounded Rates.

The author presents a new statistical solution for pricing derivatives of compounded rates. Since the replacement of LIBOR, the compounded overnight rate has become the new standard for floating-rate loans. Many contracts contain a zero-based floor. The compounded rate is a time average of a sequence of benchmark rates. Floors and caps on compounded rates are thus Asian options. Under very weak and quite general assumptions, without explicit probability distributions, the author proves that even if the benchmark rate process is non-Gaussian, the simple Gaussian model is asymptotically correct for pricing due to Lyapunov's central limit theorem. The approximation's maximum mispricing is bounded by the Berry-Esseen inequality. [ABSTRACT FROM AUTHOR]