Compounds with intermediate-size transition metals such as Fe or Mn are close to the transition between charge-transfer systems and Mott-Hubbard systems. We study the optical conductivity sigma(omega) of insulating layered LaSrFeO_4 in the energy range 0.5 - 5.5 eV from 15 K to 250 K by the use of spectroscopic ellipsometry in combination with transmittance measurements. A multipeak structure is observed in both sigma^a(omega) and sigma^c(omega). The layered structure gives rise to a pronounced anisotropy, thereby offering a means to disentangle Mott-Hubbard and charge-transfer absorption bands. We find strong evidence that the lowest dipole-allowed excitation in LaSrFeO_4 is of Mott-Hubbard type. This rather unexpected result can be attributed to Fe 3d - O 2p hybridization and in particular to the layered structure with the associated splitting of the e_g level. In general, Mott-Hubbard absorption bands may show a strong dependence on temperature. This is not the case in LaSrFeO_4, in agreement with the fact that spin-spin and orbital-orbital correlations between nearest neighbors do not vary strongly below room temperature in this compound with a high-spin 3d^5 configuration and a Neel temperature of T_N = 366 K.
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