On the Calibration of the Libor Market Model

This thesis presents a study of LIBOR market model calibration. In particular, the study builds on the prevailing calibration methodologies in an attempt to find a method that simultaneously recovers implied volatility and forward rate correlations structures from market prices of plain vanilla opti...

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Main Author: DEMELINDA, U Lagunzad
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Language:English
Published: Institutional Knowledge at Singapore Management University 2007
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Online Access:https://ink.library.smu.edu.sg/etd_coll/33
https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=1032&context=etd_coll
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spelling sg-smu-ink.etd_coll-10322010-09-08T01:24:04Z On the Calibration of the Libor Market Model DEMELINDA, U Lagunzad This thesis presents a study of LIBOR market model calibration. In particular, the study builds on the prevailing calibration methodologies in an attempt to find a method that simultaneously recovers implied volatility and forward rate correlations structures from market prices of plain vanilla options. In order to ensure that complex derivative pricing and hedging requirements are jointly addressed, the study extends the performance analysis of calibration methods from a static level of goodness-of-fit with market prices test, to a dynamic level of approximation to next period's LIBOR (London Interbank Offer Rate) dynamics when tested on a series of market prices.Among the methodologies considered, the results show that for caplets, full calibration results in least pricing error when tested on an intra-day pricing prediction, and generates a stable evolution of day-to-day implied volatility. For swaptions, analytic approximation provides better estimate on an intra-day pricing but Monte Carlo simulation with parametrized correlations matrix provides a stable evolution of volatility and correlation (or covariance). This approach for swaptions calibration outperforms the other methods used despite the modifications made in volatility and initial thetas specifications.All together, the results suggest that the Monte Carlo method with parametrized correlations appear to be superior as it provides smooth evolution of covariance of forward rates that is desired in complex derivative pricing and hedging. 2007-01-01T08:00:00Z text application/pdf https://ink.library.smu.edu.sg/etd_coll/33 https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=1032&context=etd_coll http://creativecommons.org/licenses/by-nc-nd/4.0/ Dissertations and Theses Collection (Open Access) eng Institutional Knowledge at Singapore Management University Finance and Financial Management Portfolio and Security Analysis
institution Singapore Management University
building SMU Libraries
continent Asia
country Singapore
Singapore
content_provider SMU Libraries
collection InK@SMU
language English
topic Finance and Financial Management
Portfolio and Security Analysis
spellingShingle Finance and Financial Management
Portfolio and Security Analysis
DEMELINDA, U Lagunzad
On the Calibration of the Libor Market Model
description This thesis presents a study of LIBOR market model calibration. In particular, the study builds on the prevailing calibration methodologies in an attempt to find a method that simultaneously recovers implied volatility and forward rate correlations structures from market prices of plain vanilla options. In order to ensure that complex derivative pricing and hedging requirements are jointly addressed, the study extends the performance analysis of calibration methods from a static level of goodness-of-fit with market prices test, to a dynamic level of approximation to next period's LIBOR (London Interbank Offer Rate) dynamics when tested on a series of market prices.Among the methodologies considered, the results show that for caplets, full calibration results in least pricing error when tested on an intra-day pricing prediction, and generates a stable evolution of day-to-day implied volatility. For swaptions, analytic approximation provides better estimate on an intra-day pricing but Monte Carlo simulation with parametrized correlations matrix provides a stable evolution of volatility and correlation (or covariance). This approach for swaptions calibration outperforms the other methods used despite the modifications made in volatility and initial thetas specifications.All together, the results suggest that the Monte Carlo method with parametrized correlations appear to be superior as it provides smooth evolution of covariance of forward rates that is desired in complex derivative pricing and hedging.
format text
author DEMELINDA, U Lagunzad
author_facet DEMELINDA, U Lagunzad
author_sort DEMELINDA, U Lagunzad
title On the Calibration of the Libor Market Model
title_short On the Calibration of the Libor Market Model
title_full On the Calibration of the Libor Market Model
title_fullStr On the Calibration of the Libor Market Model
title_full_unstemmed On the Calibration of the Libor Market Model
title_sort on the calibration of the libor market model
publisher Institutional Knowledge at Singapore Management University
publishDate 2007
url https://ink.library.smu.edu.sg/etd_coll/33
https://ink.library.smu.edu.sg/cgi/viewcontent.cgi?article=1032&context=etd_coll
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