Volatility skews and extensions of the Libor market model
The paper considers extensions of the Libor market model to markets with volatility skews in observable option prices. The family of forward rate processes is expanded to include diffusions with non-linear forward rate dependence, and efficient techniques for calibration to quoted prices of caps and swaptions are discussed. Special emphasis is put on generalized CEV processes for which closed-form expressions for cap and swaption prices are derived. Modifications of the CEV process which exhibit more appealing growth and boundary characteristics are also discussed. The proposed models are investigated numerically through Crank-Nicholson finite difference schemes and Monte Carlo simulations.
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Volume (Year): 7 (2000)
Issue (Month): 1 ()
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World Scientific Publishing Co. Pte. Ltd..
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- 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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- Schroder, Mark Douglas, 1989. " Computing the Constant Elasticity of Variance Option Pricing Formula," Journal of Finance, American Finance Association, vol. 44(1), pages 211-219, March. Full references (including those not matched with items on IDEAS)
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