Displaced Diffusion LMM - Addressing Lognormal Blowup
Document ID: 2009-1632
Published on: 21st December 2009
Author: Colin Holmes
Barrie & Hibbert are introducing a variant of the Libor Market Model (LMM), known as the Displaced Diffusion LMM, into our ESG software products. We are introducing this model to provide an alternative option to our existing ‘Lognormal’ interest rate models. This note will be of primary interest to Insurers calculating ‘Market-Consistent’ valuations of embedded options & guarantees.
This note provides an overview of the model’s key features, focussing on the special case of a Gaussian model. We describe how the model relates to our existing rate models, and other well-known rate models. In particular, we highlight the model’s ability to address practical difficulties caused by ‘Lognormal blowup’.
Finally, we provide a light introduction to the model’s details: further technical detail is provided in a separate Technical Note (Displaced Diffusion Libor Market Model) .
