Interpolation Schemes in the Displaced-Diffusion LIBOR Market Model and the Efficient Pricing and Greeks for Callable Range Accruals
46 Pages Posted: 26 Aug 2009 Last revised: 27 Feb 2010
Date Written: August 25, 2009
We introduce a new arbitrage-free interpolation scheme for the displaced-diffusion LIBOR market model. Using this new extension, and the Piterbarg interpolation scheme, we study the simulation of range accrual coupons when valuing callable range accruals in the displaced-diffusion LIBOR market model. We introduce a number of new improvements that lead to significant efficiency improvements, and explain how to apply the adjoint-improved pathwise method to calculate deltas and vegas under the new improvements, which was not previously possible for callable range accruals. One new improvement is based on using a Brownian-bridge-type approach to simulating the range accrual coupons. We consider a variety of examples, including when the reference rate is a LIBOR rate, when it is a spread between swap rates, and when the multiplier for the range accrual coupon is stochastic.
Keywords: LIBOR market model, BGM, range accrual, interpolation scheme, Monte Carlo, early exercise, Greeks, pathwise method, delta, vega
JEL Classification: C19, G13
Suggested Citation: Suggested Citation