Consistent calibration of HJM models to cap implied volatilities
✍ Scribed by Flavio Angelini; Stefano Herzel
- Publisher
- John Wiley and Sons
- Year
- 2005
- Tongue
- English
- Weight
- 280 KB
- Volume
- 25
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
This article proposes a calibration algorithm that fits multifactor Gaussian models to the implied volatilities of caps with the use of the respective minimal consistent family to infer the forward-rate curve. The algorithm is applied to three forward-rate volatility structures and their combination to form two-factor models. The efficiency of the consistent calibration is evaluated through comparisons with nonconsistent methods. The selection of the number of factors and of the volatility functions is supported by a principal-component analysis. Models are evaluated in terms of in-sample and out-of-sample data fitting as well as stability of parameter estimates. The results are analyzed mainly by focusing on the capability of fitting the market-implied volatility curve and, in particular, reproducing its characteristic humped shape.