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A hybrid Markov-Functional model with simultaneous calibration to the interest rate and FX smile

Christian Fries () and Fabian Eckstaedt

Quantitative Finance, 2009, vol. 11, issue 4, 587-597

Abstract: In this paper we present a Markov-Functional hybrid interest rate/foreign exchange model that allows calibration to given market volatility surfaces in both dimensions simultaneously. This is achieved by extending the approach introduced by Fries and Rott by a functional for the foreign exchange rate (FX), which allows a fast, yet accurate calibration to a given market FX volatility surface. This calibration procedure comes as an additional step to the known calibration of the LIBOR functional, resulting in an efficient implementation.

Keywords: Derivatives hedging; Derivatives pricing; Derivatives risk management; Derivative pricing models; Monte Carlo methods (search for similar items in EconPapers)
Date: 2009
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DOI: 10.1080/14697680903150488

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Handle: RePEc:taf:quantf:v:11:y:2009:i:4:p:587-597