Generic market models

DOI10.1007/S00780-006-0023-3MaRDI QIDQ881416zbMATH OpenOpenAlexFDO

Authors Raoul Pietersz, Marcel van Regenmortel

Publication date 29 May 2007

Published in Finance and Stochastics (Search for Journal in Brave)

Full work available at URL https://doi.org/10.1007/s00780-006-0023-3

zbMATH Keywords

Bermudan swaptionsconstant maturity swapdrift termsgeneric market model

Mathematics Subject Classification ID

Martingales with continuous parameter (60G44) Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20) Interest rates, asset pricing, etc. (stochastic models) (91G30)

Review text

The authors introduce generic market models featuring forward rates that span periods other than the classical LIBOR and swap periods. The main outset of the paper is that a model is deemed proper for a certain interest rate derivative if the volatility of a rate that appears in the contract payoff has been calibrated correctly to the market volatility. The new angle of this paper is that no-arbitrage is considered in the market spanned at a given time point by the various forward swap rates in a generic market model. The conditions are provided that guarantee the absence of arbitrage in these static forward agreement markets for the generic setting. The necessary and sufficient conditions are derived for the structure of the forward rates to span an arbitrage-free economy in terms of relative discount bond prices, at all times. Generic expressions are developed for the drift terms occurring in the stochastic differential equation driving the forward rates under a single pricing measure. There is demonstrated how the instantaneous correlation of the generic forward rates can be calculated from the instantaneous correlation of forward LIBOR rates. The efficiency of drift calculations is discussed.

Recommendations

• Admissibility of generic market models of forward swap rates
• LIBOR and swap market models and measures
• Continuous-time term structure models: Forward measure approach
• The Market Model of Interest Rate Dynamics
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Cites work

• Continuous-time term structure models: Forward measure approach
• scientific article; zbMATH DE number 1454625 (Why is no real title available?)
• scientific article; zbMATH DE number 1795852 (Why is no real title available?)
• scientific article; zbMATH DE number 961607 (Why is no real title available?)
• Interest-rate option models: understanding, analysing and using models for exotic interest-rate options.
• LIBOR and swap market models and measures
• The Market Model of Interest Rate Dynamics
• THEORY AND CALIBRATION OF SWAP MARKET MODELS
• Valuing American options by simulation: a simple least-squares approach

Cited in

(8)

• Analytical approximations for prices of swap rate dependent embedded options in insurance products
• Negative Libor rates in the swap market model
• Admissibility of generic market models of forward swap rates
• Smooth simultaneous calibration of the LMM to caplets and co-terminal swaptions
• Perturbation stable conditional analytic Monte-Carlo pricing scheme for auto-callable products
• THEORY AND CALIBRATION OF SWAP MARKET MODELS
• A comparison of single factor Markov-functional and multi factor market models
• Effective Implementation of Generic Market Models

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