Libor Market Models Versus Swap Market Models for Pricing Interest Rate Derivatives: An Empirical Analysis

45 Pages Posted: 17 May 2001

See all articles by Antoon Pelsser

Antoon Pelsser

Maastricht University; Netspar

Frank De Jong

Tilburg University - Department of Finance

Joost Driessen

Tilburg University - Center and Faculty of Economics and Business Administration; Tilburg University - Center for Economic Research (CentER)

Date Written: April 2001

Abstract

In this paper we empirically analyze and compare the Libor and Swap Market Models, developed by Brace, Gatarek and Musiela (1997) and Jamshidian (1997), using panel data on prices of US caplets and swaptions. A Libor Market Model can directly be calibrated to observed prices of caplets, whereas a Swap Market Model is calibrated to a certain set of swaption prices. For both one-factor and two-factor models it is analyzed how well they price caplets and swaptions that were not used for calibration. We show that the Libor Market Models in general lead to better prediction of derivative prices that were not used for calibration than the Swap Market Models. A one-factor Libor Market Model that exhibits mean-reversion gives a reasonable fit of the derivative prices, and adding a second factor only decreases pricing errors to a small extent. Also, models that are chosen to exactly match certain derivative prices are overfitted. Regression tests reveal that all models are statistically rejected, and the pricing errors are correlated with the shape of the term structure of interest rates.

Suggested Citation

Pelsser, Antoon A. J. and De Jong, Frank and Driessen, Joost, Libor Market Models Versus Swap Market Models for Pricing Interest Rate Derivatives: An Empirical Analysis (April 2001). Available at SSRN: https://ssrn.com/abstract=270394 or http://dx.doi.org/10.2139/ssrn.270394

Antoon A. J. Pelsser (Contact Author)

Maastricht University ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: http://https://sites.google.com/site/apelsseraca/

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Frank De Jong

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Joost Driessen

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Register to save articles to
your library

Register

Paper statistics

Downloads
1,199
Abstract Views
4,342
rank
16,272
PlumX Metrics