Weighted least squares estimation of the risk-free rate from derivative prices

Abstract This study proposes a method for estimating the interest spread over an OIS-implied spot rate used in market-consistent derivative pricing. Our method generalizes previous proposed ordinary least squares methods in the literature in two ways. First, it utilizes intraday data rather than data from a single time. Second, it is formulated as weighted least squares to counteract heteroscedasticity. Additionally, we present a general methodology to quantify the performance difference between methods when the true value is unknown. We find that our method outperforms previously proposed methods with statistical significance and that the primary improvement is the utilization of intraday data.