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A multicurrency extension of the lognormal interest rate Market Models

  • Erik Schlögl


    (School of Finance and Economics, University of Technology, Sydney, NSW 2007 Australia Manuscript)

The Market Models of the term structure of interest rates, in which forward LIBOR or forward swap rates are modelled to be lognormal under the forward probability measure of the corresponding maturity, are extended to a multicurrency setting. If lognormal dynamics are assumed for forward LIBOR or forward swap rates in two currencies, the forward exchange rate linking the two currencies can only be chosen to be lognormal for one maturity, with the dynamics for all other maturities given by no-arbitrage relationships. Alternatively, one could choose forward interest rates in only one currency, say the domestic, to be lognormal and postulate lognormal dynamics for all forward exchange rates, with the dynamics of foreign interest rates determined by no-arbitrage relationships.

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Article provided by Springer in its journal Finance and Stochastics.

Volume (Year): 6 (2002)
Issue (Month): 2 ()
Pages: 173-196

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Handle: RePEc:spr:finsto:v:6:y:2002:i:2:p:173-196
Note: received: July 1999; final version received: May 2001
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  1. Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330.
  2. Sandmann,Klaus & Sondermann,Dieter, . "A term structure model and the pricing of interest rate options," Discussion Paper Serie B 129, University of Bonn, Germany.
  3. Miltersen, K. & K. Sandmann & D. Sondermann, 1994. "Closed Form Solutions for Term Structure Derivatives with Log-Normal Interest Rates," Discussion Paper Serie B 308, University of Bonn, Germany.
  4. Marek Rutkowski & Marek Musiela, 1997. "Continuous-time term structure models: Forward measure approach (*)," Finance and Stochastics, Springer, vol. 1(4), pages 261-291.
  5. Rudiger Frey & Daniel Sommer, 1996. "A systematic approach to pricing and hedging international derivatives with interest rate risk: analysis of international derivatives under stochastic interest rates," Applied Mathematical Finance, Taylor & Francis Journals, vol. 3(4), pages 295-317.
  6. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
  7. Harrison, J. Michael & Pliska, Stanley R., 1983. "A stochastic calculus model of continuous trading: Complete markets," Stochastic Processes and their Applications, Elsevier, vol. 15(3), pages 313-316, August.
  8. 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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