Abstract
The class of affine LIBOR models is appealing since it satisfies three central requirements of interest rate modeling. It is arbitrage-free, interest rates are nonnegative, and caplet and swaption prices can be calculated analytically. In order to guarantee nonnegative interest rates affine LIBOR models are driven by nonnegative affine processes, a restriction that makes it hard to produce volatility smiles. We modify the affine LIBOR models in such a way that real-valued affine processes can be used without destroying the nonnegativity of interest rates. Numerical examples show that in this class of models, pronounced volatility smiles are possible.
Original language | English |
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Pages (from-to) | 333-350 |
Journal | Stochastic Models |
Volume | 32 |
Issue number | 2 |
DOIs | |
Publication status | Published - 2016 |