Advanced Interest Rate Models (HJM and LMM) › Key Parameters
Michael BrenndoerferDecember 7, 20251 min read
Quantitative FinanceAll chapters Part 7 of 15Interest Rate Models and Derivatives
Advanced Interest Rate Models (HJM and LMM) › Key ParametersOne section · Sections in this chapter3 / 13 ↓
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The key parameters for the HJM framework simulations are:
- f(0, T): Initial forward rate curve. The starting point for the evolution of the term structure, typically extracted from market bond prices or swap rates.
- σ(t, T): Volatility function. Determines the magnitude of random fluctuations and, via the drift condition, the trend of forward rates. This is the sole input needed to specify an HJM model.
- κ: Mean reversion parameter (in Hull-White specification). Controls how quickly volatility decays with maturity, influencing the correlation between forward rates of different tenors.
- dt: Time step size. Smaller steps reduce discretization error in the simulation but increase computational cost.