Affine LIBOR models with multiple curves: theory, examples and calibration

TL;DR

This paper develops a flexible affine LIBOR model framework for multiple curves that enables tractable pricing, positive interest rates, and basis spreads, with efficient calibration to market data.

Contribution

It introduces a novel affine LIBOR model framework accommodating multiple curves, positive rates, and spreads, with semi-analytic pricing and calibration methods.

Findings

Framework supports positive rates and spreads.

Fourier pricing formulas derived for derivatives.

Efficient calibration to caplet prices achieved.

Abstract

We introduce a multiple curve framework that combines tractable dynamics and semi-analytic pricing formulas with positive interest rates and basis spreads. Negatives rates and positive spreads can also be accommodated in this framework. The dynamics of OIS and LIBOR rates are specified following the methodology of the affine LIBOR models and are driven by the wide and flexible class of affine processes. The affine property is preserved under forward measures, which allows us to derive Fourier pricing formulas for caps, swaptions and basis swaptions. A model specification with dependent LIBOR rates is developed, that allows for an efficient and accurate calibration to a system of caplet prices.