Skewed Libor Market Model and Gaussian HJM Explicit Approaches to Rolled Deposit Options
16 Pages Posted: 14 Jan 2007
Date Written: January 2006
A simple exotic option (floor on rolled deposit) is studied in the shifted log-normal Libor Market (LMM) and Gaussian HJM models. The shifted log-normal LMM exhibits a controllable volatility skew. An explicit approach is used for both models. Using approximations the price in the LMM is obtained without Monte Carlo simulation. The more precise approximation uses a twisted version of the perdictor-corrector adapted to explicit solutions. The results of the approximation are surprisingly good.
Keywords: Libor Market Model, Heath-Jarrow-Morton, skew, smile, explicit solution, approximation, Bond Market Model, option on composition, existence results
JEL Classification: G13, E43, C63
Suggested Citation: Suggested Citation