Very Long-Stepping in the Spot Measure of the LIBOR Market Model
11 Pages Posted: 6 Aug 2009
Date Written: August 5, 2009
It is widely believed that when evolving rates in the LIBOR market model to step over tenor dates the terminal measure must be used. We explain why this is not the case, and show that by very long stepping in the spot measure it is possible to obtain significant accuracy and standard error improvements, leading to substantial improvements in efficiency. In particular, we demonstrate that speed-ups of a factor in the thousands are possible when pricing auto-caps if the same drift approximation is used in both measures.
Keywords: LIBOR market model, spot measure, long step, auto-cap
JEL Classification: C19, G13
Suggested Citation: Suggested Citation