Calibrating Libor Market Models

26 Pages Posted: 7 Sep 1998

Date Written: July 30, 1998

Abstract

The Libor Market Models arise from the general multi-factor Heath-Jarrow-Morton interest rate model. The Libor Market Models assume that, say, 3 months simple rates are log-normal. With pricing formulae for caps/floors and swaptions this makes the model easy to calibrate for a specific choice of volatility function. We describe how to calibrate the model using a non-parametric volatility function. We apply a smoothness criteria to the quality of fit used in calibration as erratic volatilities otherwise result from the calibration. We perform numerical studies using real market data from several markets to check the robustness of the implementation towards changes in model/calibration parameters. The implementation is indeed very robust and market quotes are matched within bid-offer spread.

JEL Classification: G13

Suggested Citation

Pedersen, Morten Bjerregaard, Calibrating Libor Market Models (July 30, 1998). Available at SSRN: https://ssrn.com/abstract=111828 or http://dx.doi.org/10.2139/ssrn.111828

Morten Bjerregaard Pedersen (Contact Author)

SimCorp - Financial Research Department ( email )

Oslo Plads 12
DK-2100 Copenhagen O
Denmark
+45 35 44 88 33 (Phone)
+45 35 44 87 87 (Fax)

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