Multiple stochastic volatility extension of the Libor market model and its implementation

Denis Belomestny, Stanley Mathew, John Schoenmakers
2009 Monte Carlo Methods and Applications  
In this paper we propose an extension of the Libor market model with a high-dimensional specially structured system of square root volatility processes, and give a road map for its calibration. As such the model is well suited for Monte Carlo simulation of derivative interest rate instruments. As a key issue, we require that the local covariance structure of the market model is preserved in the stochastic volatility extension. In a case study we demonstrate that the extended Libor model allows
more » ... or stable calibration to the cap-strike matrix. The calibration algorithm is FFT based, so fast and easy to implement.
doi:10.1515/mcma.2009.016 fatcat:hkamvgwogbb4jj22ntr6km5iui