Fast calibration of the libor market model with stochastic volatility and displaced diffusion

DOI10.3934/JIMO.2019025MaRDI QIDQ2190303zbMATH OpenOpenAlexWikidataFDO

Authors Laurent Devineau, Pierre-Edouard Arrouy, Paul Bonnefoy, Alexandre Boumezoued

Publication date 18 June 2020

Published in Journal of Industrial and Management Optimization (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1706.00263

zbMATH Keywords

displaced diffusionEdgeworth expansionsGram-Charlier expansionslibor market modelmodel calibrationstochastic volatilityswaption pricing

Mathematics Subject Classification ID

Applications of Brownian motions and diffusion theory (population genetics, absorption problems, etc.) (60J70) Applications of statistics to actuarial sciences and financial mathematics (62P05) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60)

Abstract: This paper demonstrates the efficiency of using Edgeworth and Gram-Charlier expansions in the calibration of the Libor Market Model with Stochastic Volatility and Displaced Diffusion (DD-SV-LMM). Our approach brings together two research areas; first, the results regarding the SV-LMM since the work of Wu and Zhang (2006), especially on the moment generating function, and second the approximation of density distributions based on Edgeworth or Gram-Charlier expansions. By exploring the analytical tractability of moments up to fourth order, we are able to perform an adjustment of the reference Bachelier model with normal volatilities for skewness and kurtosis, and as a by-product to derive a smile formula relating the volatility to the moneyness with interpretable parameters. As a main conclusion, our numerical results show a 98% reduction in computational time for the DD-SV-LMM calibration process compared to the classical numerical integration method developed by Heston (1993).

Recommendations

• A displaced-diffusion stochastic volatility LIBOR market model: motivation, definition and implementation
• Multiple stochastic volatility extension of the Libor market model and its implementation
• Moment approximations of displaced forward-LIBOR rates with application to swaptions
• Jacobi stochastic volatility factor for the LIBOR market model
• Smooth simultaneous calibration of the LMM to caplets and co-terminal swaptions

Cites work

• A closed-form solution for options with stochastic volatility with applications to bond and currency options
• A displaced-diffusion stochastic volatility LIBOR market model: motivation, definition and implementation
• scientific article; zbMATH DE number 3349081 (Why is no real title available?)
• Interest rate models -- theory and practice. With smile, inflation and credit
• LIBOR market model with stochastic volatility
• On the calculation of the solvency capital requirement based on nested simulations
• Option pricing where the underlying assets follow a Gram/Charlier density of arbitrary order
• Polynomial diffusions and applications in finance
• Polynomial processes and their applications to mathematical finance
• The bootstrap and Edgeworth expansion
• Volatility skews and extensions of the Libor market model

Cited in

(4)

• Economic scenario generators: a risk management tool for insurance
• Jacobi stochastic volatility factor for the LIBOR market model
• Multiple stochastic volatility extension of the Libor market model and its implementation
• A displaced-diffusion stochastic volatility LIBOR market model: motivation, definition and implementation

This page was built for publication: Fast calibration of the libor market model with stochastic volatility and displaced diffusion

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q2190303)