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The Libor Market Model: A Recombining Binomial Tree Methodology

We propose an implementation of the Libor Market Model, adapting the recombining node methodology of Ho, Stapleton and Subrahmanyam (1995). Initial tests on one-factor and two-factor versions of the model suggest that the method provides a fast and accurate approach for the valuation of path dependent interest rate derivatives such as Bermudan-style swaptions. The lattice based approach illustrated here provides an efficient alternative to Monte-Carlo simulation implementation of the Libor Market Model.

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