Interest rate models enhanced with local volatility

Frustrated man at the blackboard during a maths class

Lingling Cao, Pierre Henry-Labordère
30 Aug 2016

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Dupire’s local volatility model, widely used in equity markets, has the property of being perfectly calibrated to vanillas. In fixed income markets, models with a similar property are not available.

Recently, Gatarek, Jablecki & Qu (2016) have considered a one-dimensional Cheyette model enhanced with local volatility and have derived an (approximate) Dupire-like local volatility formula for swaptions (see also Chibane & Law (2013), where a quadratic parameterisation

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