AN EFFICIENT LATTICE ALGORITHM FOR THELIBOR MARKET MODEL
Risk Analytics, Capital Markets Risk Management, CIBC, Toronto, Canada
The LIBOR Market Model (LMM or BGM) has become one of the most popularmodels for pricing interest rate products. It is commonly believed that Monte-Carlosimulation is the only viable method available for the LIBOR Market Model. In thisarticle, however, we propose a lattice (or tree) approach to price interest rateproducts within the LIBOR Market Model by introducing a shifted forward measureand several novel fast drift approximation methods. This model should achieve thebest performance without losing much accuracy. Moreover, the calibration is almostautomatic and it is simple and easy to implement. Adding this model to the valuationtoolkit is actually quite useful; especially for risk management or in the case there isa need for a quick turnaround.
: LIBOR Market Model (LMM or BGM), lattice model, tree model, shiftedforward measure, drift approximation, risk management, calibration, callable exotics,callable bond, callable capped floater swap, callable inverse floater swap, callablerange accrual swap.
The views expressed here are of the author alone and not necessarily of his host institution.Address correspondence to Tim Xiao, Risk Analytics, Capital Markets Risk Management, CIBC,161 Bay Street, 12
Floor, Toronto, ON M5J 2S8, Canada; email:Tim.Xiao@CIBC.com