Abstract
but is known to have several pitfalls. In addition, if the model is driven by a
jump process, then the complexity of the drift term grows exponentially fast (as
a function of the tenor length). We consider a Lévy-driven LIBOR model and
aim to develop accurate and efficient log-Lévy approximations for the dynamics
of the rates. The approximations are based on the truncation of the drift term
and on Picard approximation of suitable processes. Numerical experiments for
forward-rate agreements, caps, swaptions and sticky ratchet caps show that the
approximations perform very well. In addition, we also consider the log-Lévy
approximation of annuities, which offers good approximations for high-volatility
regimes.
| Original language | English |
|---|---|
| Journal | Journal of Computational Finance |
| Volume | 15 |
| Issue number | 4 |
| Pages (from-to) | 3-44 |
| ISSN | 1460-1559 |
| Publication status | Published - 2012 |
Cite this
}
Efficient and Accurate Log-Levy Approximations of Levy-Driven LIBOR Models. / Papapantoleon, Antonis ; Schoenmakers, John ; Skovmand, David.
In: Journal of Computational Finance, Vol. 15, No. 4, 2012, p. 3-44.Research output: Contribution to journal › Journal article › Research › peer-review
TY - JOUR
T1 - Efficient and Accurate Log-Levy Approximations of Levy-Driven LIBOR Models
AU - Papapantoleon, Antonis
AU - Schoenmakers, John
AU - Skovmand, David
PY - 2012
Y1 - 2012
N2 - The LIBOR market model is very popular for pricing interest rate derivativesbut is known to have several pitfalls. In addition, if the model is driven by ajump process, then the complexity of the drift term grows exponentially fast (asa function of the tenor length). We consider a Lévy-driven LIBOR model andaim to develop accurate and efficient log-Lévy approximations for the dynamicsof the rates. The approximations are based on the truncation of the drift termand on Picard approximation of suitable processes. Numerical experiments forforward-rate agreements, caps, swaptions and sticky ratchet caps show that theapproximations perform very well. In addition, we also consider the log-Lévyapproximation of annuities, which offers good approximations for high-volatilityregimes.
AB - The LIBOR market model is very popular for pricing interest rate derivativesbut is known to have several pitfalls. In addition, if the model is driven by ajump process, then the complexity of the drift term grows exponentially fast (asa function of the tenor length). We consider a Lévy-driven LIBOR model andaim to develop accurate and efficient log-Lévy approximations for the dynamicsof the rates. The approximations are based on the truncation of the drift termand on Picard approximation of suitable processes. Numerical experiments forforward-rate agreements, caps, swaptions and sticky ratchet caps show that theapproximations perform very well. In addition, we also consider the log-Lévyapproximation of annuities, which offers good approximations for high-volatilityregimes.
M3 - Journal article
VL - 15
SP - 3
EP - 44
JO - Journal of Computational Finance
JF - Journal of Computational Finance
SN - 1460-1559
IS - 4
ER -