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An n-dimensional Markov-functional interest rate model
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Kaisajuntti , Linus and Kennedy, J. E. (2013) An n-dimensional Markov-functional interest rate model. Journal of Computational Finance, Volume 17 (Number 1). pp. 3-41. ISSN 1460-1559.
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Abstract
This paper develops an n-dimensional Markov-functional interest rate model, i.e. a model driven by an n-dimensional state process and constructed using Markov-functional techniques. It is shown that this model is very similar to an n-factor LIBOR market model hence allowing intuition from the LIBOR market model to be transferred to the Markov-functional model. This generalises the results of Bennett & Kennedy (2005) from one-dimensional to n-dimensional driving state processes. The model is suitable for pricing certain type of exotic interest rate derivative products such as TARNs on LIBORs or CMS spreads. For these products, the n-dimensional Markov-functional model may be used as a benchmark model allowing for powerful and flexible control of both correlations between different rates as well as skews/smiles in implied volatilities.
Item Type: | Journal Article | ||||
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Divisions: | Faculty of Science, Engineering and Medicine > Science > Statistics | ||||
Journal or Publication Title: | Journal of Computational Finance | ||||
Publisher: | Incisive Media Ltd. | ||||
ISSN: | 1460-1559 | ||||
Official Date: | 2013 | ||||
Dates: |
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Volume: | Volume 17 | ||||
Number: | Number 1 | ||||
Page Range: | pp. 3-41 | ||||
Status: | Peer Reviewed | ||||
Publication Status: | Published | ||||
Access rights to Published version: | Restricted or Subscription Access | ||||
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