AN EFFICIENT CALIBRATION METHOD FOR THE MULTI-FACTOR LIBOR MARKET MODEL AND ITS APPLICATION TO THE JAPANESE MARKET

Hidetoshi Tanimura () and Yuji Yamada ()
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Hidetoshi Tanimura: Graduate School of Business Sciences, University of Tsukuba, 3-29-1 Otsuka, Bunkyo-ku, Tokyo 112-0012, Japan
Yuji Yamada: Graduate School of Business Sciences, University of Tsukuba, 3-29-1 Otsuka, Bunkyo-ku, Tokyo 112-0012, Japan

International Journal of Theoretical and Applied Finance (IJTAF), 2006, vol. 09, issue 07, 1123-1139

Abstract: In this paper an efficient calibration method for the multi-factor LIBOR Market Model (LMM) is proposed and is applied for the Japanese interest rate market. At first the joint calibration method in the cap and swaption market is demonstrated using a new parameterization for the correlation matrix in the LMM. Then we implement the proposed methodology for calibrating the Japanese cap and swaption markets, where the computational procedure is shown to be tractable and provides a practical estimation for the implied correlation matrix in the LMM. The empirical analysis also illustrates that Black's swaption volatilities through our calibration fit the market data almost exactly and that the estimated implied correlation matrix is smooth and stable.

Keywords: LIBOR market model; parameter calibration; implied correlation matrix (search for similar items in EconPapers)
Date: 2006
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DOI: 10.1142/S0219024906003913

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