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ntruwant
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Posts: 121
Joined: August 3rd, 2004, 9:50 am

calibration of LMM on current caps: simulated yield curves too high

June 9th, 2010, 7:21 am

Hi,calibrating a LMM on caps (caplet) with underlying volatilities of 50% results in simulated yield curves attaigning levels of 30% interest rates, which is not realistic.Are there techniques to deduce more realistic underlying volatilities from the caps/caplets, that result in less extreme simulated yield curves?
 
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manolom
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Joined: March 14th, 2006, 2:52 pm

calibration of LMM on current caps: simulated yield curves too high

June 9th, 2010, 9:41 am

The point here is not that extreme scenarios occur, but how often.
 
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frattyquant
Posts: 362
Joined: March 4th, 2010, 8:10 am

calibration of LMM on current caps: simulated yield curves too high

June 11th, 2010, 2:56 am

While I fully agree with manolom, you could set some sort of cap/floor in your algorithm that discards the paths in which the rate goes above a level you believe to be unreasonable.