Calibration of the Multi-Currency LIBOR Market Model

Abstract

This paper presents a method for calibrating a multicurrency lognormal LIBOR Market Model to market data of at-the-money caps, swaptions and FX options. By exploiting the fact that multivariate normal distributions are invariant under orthonormal transformations, the calibration problem is decomposed into manageable stages, while maintaining the ability to achieve realistic correlation structures between all modelled market variables.

Keywords: Currency options, LIBOR Market Model, exchange rate risk, interest rate risk

JEL Classification: G13