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A Random Field LIBOR Market Model
Author(s) -
Wu Tao L.,
Xu Shengqiang
Publication year - 2014
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.21654
Subject(s) - libor market model , libor , econometrics , volatility (finance) , skew , field (mathematics) , economics , computer science , interest rate , mathematics , finance , telecommunications , pure mathematics
A random field LIBOR market model (RFLMM) is proposed by extending the LIBOR market model, with interest rate uncertainties modeled via a random field. First, closed‐form formulas for pricing caplet and swaption are derived. Then the random field LIBOR market model is integrated with the lognormal‐mixture model to capture the implied volatility skew/smile. Finally, the model is calibrated to cap volatility surface and swaption volatilities. Numerical results show that the random field LIBOR market model can potentially outperform the LIBOR market model in capturing caplet volatility smile and the pricing of swaptions, in addition to possessing other advantages documented in the previous literature (no need of frequent recalibration or to specify the number of factors in advance). © 2014 Wiley Periodicals, Inc. Jrl Fut Mark 34:580–606, 2014