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Time-changed Levy LIBOR market model: Pricing and joint estimation of the cap surface and swaption cube


Leippold, Markus; Stromberg, Jacob (2014). Time-changed Levy LIBOR market model: Pricing and joint estimation of the cap surface and swaption cube. Journal of Financial Economics, 111(1):224-250.

Abstract

We propose a novel time-changed Lévy LIBOR (London Interbank Offered Rate) market model for jointly pricing of caps and swaptions. The time changes are split into three components. The first component allows matching the volatility term structure, the second generates stochastic volatility, and the third accommodates for stochastic skew. The parsimonious model is flexible enough to accommodate the behavior of both caps and swaptions. For the joint estimation we use a comprehensive data set spanning the financial crisis of 2007–2010. We find that, even during this period, neither market is as fragmented as suggested by the previous literature.

Abstract

We propose a novel time-changed Lévy LIBOR (London Interbank Offered Rate) market model for jointly pricing of caps and swaptions. The time changes are split into three components. The first component allows matching the volatility term structure, the second generates stochastic volatility, and the third accommodates for stochastic skew. The parsimonious model is flexible enough to accommodate the behavior of both caps and swaptions. For the joint estimation we use a comprehensive data set spanning the financial crisis of 2007–2010. We find that, even during this period, neither market is as fragmented as suggested by the previous literature.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:1 January 2014
Deposited On:30 Jul 2014 13:27
Last Modified:05 Apr 2016 17:59
Publisher:Elsevier
ISSN:0304-405X
Publisher DOI:https://doi.org/10.1016/j.jfineco.2013.08.016
Official URL:http://www.sciencedirect.com/science/article/pii/S0304405X13002304
Other Identification Number:merlin-id:9514

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