New LIBOR market model revolutionizes interest rate derivatives calibration.
A new LIBOR market model was created and calibrated to caps and swaptions. It is a two-factor model with unique volatility functions that are accurate for short time horizons. The calibration process is quick and yields excellent results. The model also has a related short-rate model. The study shows that the volatility functions can be used in the short-rate model without adjustments.