A TWO-REGIME, STOCHASTIC-VOLATILITY EXTENSION OF THE LIBOR MARKET MODEL

Riccardo Rebonato and Dherminder Kainth
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Riccardo Rebonato: Royal Bank of Scotland Quantitative Research Centre (QUARC), 135 Bishopsgate, EC2M 3UR, London, UK;
Dherminder Kainth: Royal Bank of Scotland Quantitative Research Centre (QUARC), 135 Bishopsgate, EC2M 3UR, London, UK

International Journal of Theoretical and Applied Finance (IJTAF), 2004, vol. 07, issue 05, 555-575

Abstract: We propose a two-regime stochastic volatility extension of the LIBOR market model that preserves the positive features of the recently introduced (Joshi and Rebonato 2001) stochastic-volatility LIBOR market model (ease of calibration to caplets and swaptions, efficient pricing of complex derivatives, etc.) and overcomes most of its shortcomings. We show the improvements by analyzing empirically and theoretically the real and the model-produced change sin swaption implied volatility.

Keywords: LIBOR market model; stochastic volatility; regime shift; Markov processes; fitting to caplet prices (search for similar items in EconPapers)
Date: 2004
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DOI: 10.1142/S0219024904002591

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