A flexible matrix Libor model with smiles

Da Fonseca, José; Gnoatto, Alessandro and Grasselli, Martino (2013): A flexible matrix Libor model with smiles. In: Journal of Economic Dynamics and Control, Vol. 37, No. 4: pp. 774-793

Abstract

We present a flexible approach for the valuation of interest rate derivatives based on affine processes. We extend the methodology proposed in Keller-Ressel et al. (in press) by changing the choice of the state space. We provide semi-closed-form solutions for the pricing of caps and floors. We then show that it is possible to price swaptions in this multifactor setting with a good degree of analytical tractability. This is done via the Edgeworth expansion approach developed in Collin-Dufresne and Goldstein (2002). A numerical exercise illustrates the flexibility of Wishart Libor model in describing the movements of the implied volatility surface.

• Item Type: Journal article
• Faculties: Mathematics, Computer Science and Statistics > Mathematics > Workgroup Financial Mathematics
• Subjects: 500 Science > 510 Mathematics
• ISSN: 01651889
• Language: English