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Arbitrage-Free Interpolation in Models of Market Observable Interest Rates

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  • Erik Schlogl

Abstract

Models which postulate lognormal dynamics for interest rates which are compounded according to market conventions, such as forward LIBOR or forward swap rates, can be constructed initially in a discrete tenor framework. Interpolating interest rates between maturities in the discrete tenor structure is equivalent to extending the model to continuous tenor. The present paper sets forth an alternative way of performing this extension; one which preserves the Markovian properties of the discrete tenor models and guarantees the positivity of all interpolated rates.

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  • Erik Schlogl, 2018. "Arbitrage-Free Interpolation in Models of Market Observable Interest Rates," Papers 1806.08107, arXiv.org.
    • Handle: RePEc:arx:papers:1806.08107
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    1. Farshid Jamshidian, 1997. "LIBOR and swap market models and measures (*)," Finance and Stochastics, Springer, vol. 1(4), pages 293-330.
    2. Tim Dun & Geoff Barton & Erik Schlögl, 2001. "Simulated Swaption Delta–Hedging In The Lognormal Forward Libor Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 4(04), pages 677-709.
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    Cited by:

    1. Yang Chang & Erik Schlogl, 2014. "A Consistent Framework for Modelling Basis Spreads in Tenor Swaps," Research Paper Series 348, Quantitative Finance Research Centre, University of Technology, Sydney.
    2. Kay Pilz & Erik Schlogl, 2010. "Calibration of Multicurrency LIBOR Market Models," Research Paper Series 286, Quantitative Finance Research Centre, University of Technology, Sydney.
    3. Lech A. Grzelak & Cornelis W. Oosterlee, 2012. "On Cross-Currency Models with Stochastic Volatility and Correlated Interest Rates," Applied Mathematical Finance, Taylor & Francis Journals, vol. 19(1), pages 1-35, February.
    4. Yang Chang, 2014. "A Consistent Approach to Modelling the Interest Rate Market Anomalies Post the Global Financial Crisis," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 18, July-Dece.
    5. Grzelak, Lech & Oosterlee, Kees, 2010. "An Equity-Interest Rate Hybrid Model With Stochastic Volatility and the Interest Rate Smile," MPRA Paper 20574, University Library of Munich, Germany.
    6. Raoul Pietersz & Marcel Regenmortel, 2006. "Generic market models," Finance and Stochastics, Springer, vol. 10(4), pages 507-528, December.
      • Raoul Pietersz & Marcel van Regenmortel, 2005. "Generic Market Models," Finance 0502009, University Library of Munich, Germany.
      • Pietersz, R. & van Regenmortel, M., 2005. "Generic Market Models," ERIM Report Series Research in Management ERS-2005-010-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    7. Christopher Beveridge & Mark Joshi, 2014. "The Efficient Computation Of Prices And Greeks For Callable Range Accruals Using The Displaced-Diffusion Lmm," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 17(01), pages 1-47.
    8. Mark H. A. Davis & Vicente Mataix-Pastor, 2009. "Arbitrage-Free Interpolation Of The Swap Curve," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(07), pages 969-1005.
    9. Yang Chang, 2014. "A Consistent Approach to Modelling the Interest Rate Market Anomalies Post the Global Financial Crisis," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 2-2014, January-A.
    10. Erik Schlögl, 2002. "Extracting the Joint Volatility Structure of Foreign Exchange and Interest Rates from Option Prices," Research Paper Series 79, Quantitative Finance Research Centre, University of Technology, Sydney.
    11. K. F. Pilz & E. Schlögl, 2013. "A hybrid commodity and interest rate market model," Quantitative Finance, Taylor & Francis Journals, vol. 13(4), pages 543-560, March.

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