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A flexible matrix Libor model with smiles

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  • Da Fonseca, José
  • Gnoatto, Alessandro
  • Grasselli, Martino

Abstract

We present a flexible approach for the valuation of interest rate derivatives based on affine processes. We extend the methodology proposed in Keller-Ressel et al. (in press) by changing the choice of the state space. We provide semi-closed-form solutions for the pricing of caps and floors. We then show that it is possible to price swaptions in this multifactor setting with a good degree of analytical tractability. This is done via the Edgeworth expansion approach developed in Collin-Dufresne and Goldstein (2002). A numerical exercise illustrates the flexibility of Wishart Libor model in describing the movements of the implied volatility surface.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 37 (2013)
Issue (Month): 4 ()
Pages: 774-793

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:4:p:774-793

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Web page: http://www.elsevier.com/locate/jedc

Related research

Keywords: Affine processes; Wishart process; Libor market model; Fast Fourier transform; Caps; Floors; Swaptions;

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Cited by:
  1. Francesca Biagini & Alessandro Gnoatto & Maximilian H\"artel, 2013. "Affine HJM Framework on $S_{d}^{+}$ and Long-Term Yield," Papers 1311.0688, arXiv.org.
  2. Guarin, Alexander & Liu, Xiaoquan & Ng, Wing Lon, 2014. "Recovering default risk from CDS spreads with a nonlinear filter," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 87-104.
  3. Christa Cuchiero & Claudio Fontana & Alessandro Gnoatto, 2014. "A general HJM framework for multiple yield curve modeling," Papers 1406.4301, arXiv.org.

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