A new approach to LIBOR modeling

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A new approach to LIBOR modeling

Author Info

Martin Keller-Ressel
Antonis Papapantoleon
Josef Teichmann

Abstract

We provide a general and flexible approach to LIBOR modeling based on the class of affine factor processes. Our approach respects the basic economic requirement that LIBOR rates are non-negative, and the basic requirement from mathematical finance that LIBOR rates are analytically tractable martingales with respect to their own forward measure. Additionally, and most importantly, our approach also leads to analytically tractable expressions of multi-LIBOR payoffs. This approach unifies therefore the advantages of well-known forward price models with those of classical LIBOR rate models. Several examples are added and prototypical volatility smiles are shown. We believe that the CIR-process based LIBOR model might be of particular interest for applications, since closed form valuation formulas for caps and swaptions are derived.

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Paper provided by arXiv.org in its series Quantitative Finance Papers with number 0904.0555.

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Date of creation: Apr 2009
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Handle: RePEc:arx:papers:0904.0555

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179. [Downloadable!] (restricted)
Ernst Eberlein & Fehmi Özkan, 2005. "The Lévy LIBOR model," Finance and Stochastics, Springer, vol. 9(3), pages 327-348, 07. [Downloadable!] (restricted)
Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330. [Downloadable!] (restricted)
Martin Keller-Ressel & Thomas Steiner, 2008. "Yield curve shapes and the asymptotic short rate distribution in affine one-factor models," Finance and Stochastics, Springer, vol. 12(2), pages 149-172, April. [Downloadable!] (restricted)

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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Ernst Eberlein & Kathrin Glau & Antonis Papapantoleon, 2008. "Analysis of Fourier transform valuation formulas and applications," Quantitative Finance Papers 0809.3405, arXiv.org, revised Sep 2009. [Downloadable!]
Antonis Papapantoleon, 2009. "Old and new approaches to LIBOR modeling," Quantitative Finance Papers 0910.4941, arXiv.org. [Downloadable!]

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