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Hedging performance of the Libor market model: the cap market case

Sami Attaoui

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Abstract: This article investigates the hedging performance of the Libor Market Model (LMM) as well as the need to use models that explicitly incorporate Volatility Specific Factors (VSF) to better the hedging results. We compare the hedging performance of a standard LMM to that of a Constant Elasticity of Variance (CEV) LMM and find that, although the volatility risk is not completely removed by a hedge portfolio composed only of bonds, using a standard LMM is adequate to obtain high hedging performance in the cap market.

Keywords: interest rate caps; Libor market model; constant elasticity of variance; hedging (search for similar items in EconPapers)
Date: 2011-08
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Published in Applied Financial Economics, 2011, Volume 21 (N° 16), p. 1215-1223. ⟨10.1080/09603107.2011.568391⟩

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DOI: 10.1080/09603107.2011.568391

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