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Time-changed Lévy LIBOR market model: Pricing and joint estimation of the cap surface and swaption cube

  • Leippold, Markus
  • Strømberg, Jacob
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    We propose a novel time-changed Lévy LIBOR (London Interbank Offered Rate) market model for jointly pricing of caps and swaptions. The time changes are split into three components. The first component allows matching the volatility term structure, the second generates stochastic volatility, and the third accommodates for stochastic skew. The parsimonious model is flexible enough to accommodate the behavior of both caps and swaptions. For the joint estimation we use a comprehensive data set spanning the financial crisis of 2007–2010. We find that, even during this period, neither market is as fragmented as suggested by the previous literature.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X13002304
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    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 111 (2014)
    Issue (Month): 1 ()
    Pages: 224-250

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    Handle: RePEc:eee:jfinec:v:111:y:2014:i:1:p:224-250
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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