We analyze the liquidity component in a derivative transaction where both counterparties can default, and the effect of a counterparty's default probability on his funding costs and benefits. The analysis shows that the value of a transaction is influenced not by the total cost of funding of a...

This work focuses on the swaptions automatic cascade calibration algorithm (CCA) for the LIBOR Market Model (LMM) first appeared in Brigo and Mercurio (2001). This method induces a direct analytical correspondence between market swaption volatilities and LMM parameters, and allows for a perfect...

The behaviour of a smile model when applied to hedging should be consistent with market evidence that asset prices and market smiles move in the same direction (Hagan et al. 2002). Local volatility models are criticized because not consistent with this desired behaviour, and this has been an...

In this work we consider three problems of the standard market approach to the pricing of credit index options: the definition of the index spread is not valid in general, the payoff considered leads to a pricing which is not always defined, and the candidate numeraire to define a pricing...

The SABR closed-form formula (Hagan et. al 2002) is the standard for smile-consistent pricing in the swaption market. Here we address the issue of turning SABR assumptions into a consistent and arbitrage-free term structure model in the BGM/Libor Market Model framework. We compute the joint...

We present a simple methodology to guarantee that the total correlation structure in a Term Structure Model with one stochastic volatility factor remains positive semidefinite. We design the parameterization with the purpose of keeping as much freedom as possible for the correlation of interest...