Time-changed Lévy LIBOR market model: Pricing and joint estimation of the cap surface and swaption cube

Markus Leippold () and Jacob Strømberg

Journal of Financial Economics, 2014, vol. 111, issue 1, 224-250

Abstract: We propose a novel time-changed Lévy LIBOR (London Interbank Offered Rate) market model for jointly pricing of caps and swaptions. The time changes are split into three components. The first component allows matching the volatility term structure, the second generates stochastic volatility, and the third accommodates for stochastic skew. The parsimonious model is flexible enough to accommodate the behavior of both caps and swaptions. For the joint estimation we use a comprehensive data set spanning the financial crisis of 2007–2010. We find that, even during this period, neither market is as fragmented as suggested by the previous literature.

Keywords: LIBOR market models; Time-changed Lévy process; Caps volatilities; Swaption cube; Unscented Kalman filter (search for similar items in EconPapers)
JEL-codes: C51 E43 G13 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Time-Changed Lévy LIBOR Market Model: Pricing and Joint Estimation of the Cap Surface and Swaption Cube (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:111:y:2014:i:1:p:224-250

DOI: 10.1016/j.jfineco.2013.08.016

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