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A hybrid Markov-Functional model with simultaneous calibration to the interest rate and FX smile

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  • Christian Fries
  • Fabian Eckstaedt

Abstract

In this paper we present a Markov-Functional hybrid interest rate/foreign exchange model that allows calibration to given market volatility surfaces in both dimensions simultaneously. This is achieved by extending the approach introduced by Fries and Rott by a functional for the foreign exchange rate (FX), which allows a fast, yet accurate calibration to a given market FX volatility surface. This calibration procedure comes as an additional step to the known calibration of the LIBOR functional, resulting in an efficient implementation.

Suggested Citation

  • Christian Fries & Fabian Eckstaedt, 2009. "A hybrid Markov-Functional model with simultaneous calibration to the interest rate and FX smile," Quantitative Finance, Taylor & Francis Journals, vol. 11(4), pages 587-597.
    • Handle: RePEc:taf:quantf:v:11:y:2009:i:4:p:587-597
    DOI: 10.1080/14697680903150488
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    Cited by:

    1. Antonis Papapantoleon, 2010. "Old and new approaches to LIBOR modeling," Statistica Neerlandica, Netherlands Society for Statistics and Operations Research, vol. 64(3), pages 257-275, August.

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