Simulating the Libor Market Model Under Different Probability Measures: A Cure for Exploding Rates?
Document ID: 2009-1284
Published on: 3rd February 2009
Author: Steven Morrison
Under the normal “risk-neutral” measure, the Libor Market Model suffers from the phenomenon of exploding interest rates i.e. extremely large interest-rates occur with non-negligible probability and, in turn, result in extremely large cash rollups.
This note describes how the Libor Market Model can be simulated under different choices of probability measure and illustrates the effect on distributions on interest-rates and cash rollups.
