Abstract

http://ssrn.com/abstract=1729828
 
 

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Arbitrage-Free Rate Interpolation Scheme for Libor Market Model with Smooth Volatility Term Structure


Roman Werpachowski


Independent

December 22, 2010


Abstract:     
The Libor Market Model describes the evolution of a discrete subset of all interest rates quoted in the market. Generation of the complete yield curve from a simulated set of rates (the so-called "Libor rate interpolation") is one of the basic challenges which are faced by a practical user of LMM. Incorrect implementation can lead to arbitrage in the model and render generated prices invalid. In this paper, we present a rate interpolation scheme which not only is arbitrage-free, but also generates a natural-looking, smooth term structure of interpolated rates' volatilities. It is conceptually simple and computationally efficient.

Number of Pages in PDF File: 10

Keywords: LMM, BGM, rate interpolation, rate, interpolation ,Libor, volatility, volatility term structure

JEL Classification: G13

working papers series





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Date posted: December 24, 2010 ; Last revised: December 29, 2010

Suggested Citation

Werpachowski, Roman, Arbitrage-Free Rate Interpolation Scheme for Libor Market Model with Smooth Volatility Term Structure (December 22, 2010). Available at SSRN: http://ssrn.com/abstract=1729828 or http://dx.doi.org/10.2139/ssrn.1729828

Contact Information

Roman Werpachowski (Contact Author)
Independent ( email )
No Address Available
United States
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