Calibration of the LIBOR Market Model: Three Prescriptions

13 Pages Posted: 4 Mar 2003  

Dariusz Gatarek

Deloitte & Touche CE

Abstract

Pricing of European or even exotic (but without early exercise feature) interest rate and swap options in LIBOR market model can be easily performed in so called "Monsieur Jourdain approach". The general concept of "Monsieur Jourdain approach" is such, that all interest rate options without early exercise feature follow the Black-Merton-Scholes model. To this end we construct a set of "building blocks" consisting of volatilities of forward Libor rates and correlation parameters. A prescription for how to price a large class of instruments using forward Libor volatilities and the yield curve will be presented. Instantaneous volatilities are not used for model calibration and so the procedure is quite straightforward. In the paper we present three simple calibrations of the LIBOR market model useful in pricing.

Keywords: Libor market model, calibration

Suggested Citation

Gatarek, Dariusz, Calibration of the LIBOR Market Model: Three Prescriptions. Available at SSRN: https://ssrn.com/abstract=359000 or http://dx.doi.org/10.2139/ssrn.359000

Dariusz Gatarek (Contact Author)

Deloitte & Touche CE ( email )

Fredry 6
Warsaw, 00-097
Poland

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