A Simple Approximation for the No-Arbitrage Drifts for LMM-SABR-Family Interest-Rate Models

10 Pages Posted: 5 Feb 2015

See all articles by Riccardo Rebonato

Riccardo Rebonato

University of Oxford - Mathematical Institute

Date Written: February 4, 2013

Abstract

The paper present a simple, yet surprisingly effective, approximation for the no-arbitrage drifts that appear in LMM(-SABR)-family term structure models. The approximation reduces the burden of the computational bottleneck for these models by one order of magnitude. As the size of the problem increases it becomes asymptotically exact for a wide class of correlation structures. We show the effectiveness of the approximation in a particularly severe stress case.

Keywords: LMM model, SABR model, LMM-SABR model, interest-rate models, correlation, drift correction

Suggested Citation

Rebonato, Riccardo, A Simple Approximation for the No-Arbitrage Drifts for LMM-SABR-Family Interest-Rate Models (February 4, 2013). Available at SSRN: https://ssrn.com/abstract=2560241 or http://dx.doi.org/10.2139/ssrn.2560241

Riccardo Rebonato (Contact Author)

University of Oxford - Mathematical Institute ( email )

United Kingdom

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