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An Efficient Calibration Method For The Multi-Factor Libor Market Model And Its Application To The Japanese Market

Author

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  • HIDETOSHI TANIMURA

    (Graduate School of Business Sciences, University of Tsukuba, 3-29-1 Otsuka, Bunkyo-ku, Tokyo 112-0012, Japan)

  • YUJI YAMADA

    (Graduate School of Business Sciences, University of Tsukuba, 3-29-1 Otsuka, Bunkyo-ku, Tokyo 112-0012, Japan)

Abstract

In this paper an efficient calibration method for the multi-factor LIBOR Market Model (LMM) is proposed and is applied for the Japanese interest rate market. At first the joint calibration method in the cap and swaption market is demonstrated using a new parameterization for the correlation matrix in the LMM. Then we implement the proposed methodology for calibrating the Japanese cap and swaption markets, where the computational procedure is shown to be tractable and provides a practical estimation for the implied correlation matrix in the LMM. The empirical analysis also illustrates that Black's swaption volatilities through our calibration fit the market data almost exactly and that the estimated implied correlation matrix is smooth and stable.

Suggested Citation

  • Hidetoshi Tanimura & Yuji Yamada, 2006. "An Efficient Calibration Method For The Multi-Factor Libor Market Model And Its Application To The Japanese Market," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 9(07), pages 1123-1139.
    • Handle: RePEc:wsi:ijtafx:v:09:y:2006:i:07:n:s0219024906003913
    DOI: 10.1142/S0219024906003913
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    References listed on IDEAS

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    1. Bruce Choy & Tim Dun & Erik Schlögl, 2003. "Correlating Market Models," Research Paper Series 105, Quantitative Finance Research Centre, University of Technology, Sydney.
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