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Libor Market Model and Gaussian HJM explicit approaches to option on composition

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Author Info

  • Marc Henrard

    (Bank for International Settlements)

Abstract

The twin brothers Libor Market and Gaussian HJM models are investigated. A simple exotic option, floor on composition, is studied. The same explicit approach is used for both models. Using an approximation the LLM price is obtained without Monte Carlo simulation. The results of the approximation are very good, with an error well below the uncertainty due to the simulation. The appendices proves the existence of the (modified) normal and shifted log-normal LLM used in the pricing. The link of the latter with the Ho and Lee continuous time model is described.

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File URL: http://128.118.178.162/eps/fin/papers/0511/0511016.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0511016.

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Length: 11 pages
Date of creation: 29 Nov 2005
Date of revision: 07 Dec 2005
Handle: RePEc:wpa:wuwpfi:0511016

Note: Type of Document - pdf; pages: 11. Draft version, comments welcome
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Web page: http://128.118.178.162

Related research

Keywords: explicit formula; Libor market model; HJM model; shifted log-normal model; normal model; existence; option on composition;

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References

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  1. Ho, Thomas S Y & Lee, Sang-bin, 1986. " Term Structure Movements and Pricing Interest Rate Contingent Claims," Journal of Finance, American Finance Association, vol. 41(5), pages 1011-29, December.
  2. Eymen Errais & Fabio Mercurio, 2005. "Yes, Libor Models can capture Interest Rate Derivatives Skew : A Simple Modelling Approach," Computing in Economics and Finance 2005 192, Society for Computational Economics.
  3. Marc Henrard, 2004. "Swaptions: 1 price, 10 deltas, and ... 6 1/2 gammas," Finance 0407018, EconWPA, revised 14 Aug 2004.
  4. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January.
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Cited by:
  1. Henrard, Marc, 2007. "Skewed Libor Market Model and Gaussian HJM explicit approaches to rolled deposit options," MPRA Paper 1534, University Library of Munich, Germany.

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