The Lévy LIBOR model |
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Authors: | Ernst Eberlein Fehmi Özkan |
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Affiliation: | (1) Department of Mathematical Stochastics, University of Freiburg, Eckerstraße 1, 79104 Freiburg, Germany;(2) Freiburg Center for Data Analysis and Modeling, University of Freiburg, Eckerstraße 1, 79104 Freiburg, Germany |
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Abstract: | Models driven by Lévy processes are attractive because of their greater flexibility compared to classical diffusion models. First we derive the dynamics of the LIBOR rate process in a semimartingale as well as a Lévy Heath-Jarrow-Morton setting. Then we introduce a Lévy LIBOR market model. In order to guarantee positive rates, the LIBOR rate process is constructed as an ordinary exponential. Via backward induction we get that the rates are martingales under the corresponding forward measures. An explicit formula to price caps and floors which uses bilateral Laplace transforms is derived. |
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Keywords: | Lé vy processes LIBOR market model forward process instantaneous forward rates caps floors |
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