Correlations in L�vy interest rate models

Maximilian Beinhofer, Ernst Eberlein, Arend Janssen and Manuel Polley

Quantitative Finance, 2011, vol. 11, issue 9, 1315-1327

Abstract: In a series of papers during the last ten years an interest rate theory with models which are driven by L�vy or more general processes has been developed. In this paper we derive explicit formulas for the correlations of interest rates as well as zero coupon bonds with different maturities. The models considered in this general setting are the forward rate (HJM), the forward process and the LIBOR model as well as the multicurrency extension of the latter. Specific subclasses of the class of generalized hyperbolic L�vy motions are studied as driving processes. Based on a data set of parametrized yield curves derived from German government bond prices we estimate correlations. In a second step the empirical correlations are used to calibrate the L�vy forward rate model. The superior performance of the L�vy driven models becomes obvious from the graphs.

Date: 2011
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DOI: 10.1080/14697688.2010.542299

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