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Affine LIBOR models driven by real-valued affine processes

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  • Stefan Waldenberger
  • Wolfgang Muller

Abstract

The class of affine LIBOR models is appealing since it satisfies three central requirements of interest rate modeling. It is arbitrage-free, interest rates are nonnegative and caplet and swaption prices can be calculated analytically. In order to guarantee nonnegative interest rates affine LIBOR models are driven by nonnegative affine processes, a restriction, which makes it hard to produce volatility smiles. We modify the affine LIBOR models in such a way that real-valued affine processes can be used without destroying the nonnegativity of interest rates. Numerical examples show that in this class of models pronounced volatility smiles are possible.

Suggested Citation

  • Stefan Waldenberger & Wolfgang Muller, 2015. "Affine LIBOR models driven by real-valued affine processes," Papers 1503.00864, arXiv.org.
    • Handle: RePEc:arx:papers:1503.00864
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    References listed on IDEAS

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    4. repec:bla:jfinan:v:44:y:1989:i:1:p:205-09 is not listed on IDEAS
    5. Da Fonseca, José & Gnoatto, Alessandro & Grasselli, Martino, 2013. "A flexible matrix Libor model with smiles," Journal of Economic Dynamics and Control, Elsevier, vol. 37(4), pages 774-793.
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    Cited by:

    1. Stefan Waldenberger, 2015. "The affine inflation market models," Papers 1503.04979, arXiv.org.

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