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A Two-Regime, Stochastic-Volatility Extension Of The Libor Market Model

Author

Listed:
  • RICCARDO REBONATO

    (Royal Bank of Scotland Quantitative Research Centre (QUARC), 135 Bishopsgate, EC2M 3UR, London, UK;
    Oxford University — OCIAM, UK)

  • DHERMINDER KAINTH

    (Royal Bank of Scotland Quantitative Research Centre (QUARC), 135 Bishopsgate, EC2M 3UR, London, UK)

Abstract

We propose a two-regime stochastic volatility extension of the LIBOR market model that preserves the positive features of the recently introduced (Joshi and Rebonato 2001) stochastic-volatility LIBOR market model (ease of calibration to caplets and swaptions, efficient pricing of complex derivatives, etc.) and overcomes most of its shortcomings. We show the improvements by analyzing empirically and theoretically the real and the model-produced change sin swaption implied volatility.

Suggested Citation

  • Riccardo Rebonato & Dherminder Kainth, 2004. "A Two-Regime, Stochastic-Volatility Extension Of The Libor Market Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 7(05), pages 555-575.
    • Handle: RePEc:wsi:ijtafx:v:07:y:2004:i:05:n:s0219024904002591
    DOI: 10.1142/S0219024904002591
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    References listed on IDEAS

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    1. Nicolas Merener & Paul Glasserman, 2003. "Numerical solution of jump-diffusion LIBOR market models," Finance and Stochastics, Springer, vol. 7(1), pages 1-27.
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    Cited by:

    1. Riccardo Rebonato & Valerio Gaspari, 2006. "Analysis of drawdowns and drawups in the US$ interest-rate market," Quantitative Finance, Taylor & Francis Journals, vol. 6(4), pages 297-326.
    2. Riccardo Rebonato, 2006. "Forward-Rate Volatilities And The Swaption Matrix: Why Neither Time-Homogeneity Nor Time-Dependence Are Enough," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 9(05), pages 705-746.

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