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Estimating Future Floating Swap Rates with a Libor Market Model

Article Quant Q&A · Author: user12348
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Summary

The question concerns estimating a later floating-rate swap payment when the next reset payment is already known but a subsequent rate has not yet been set. The response points to modeling forward Libor rates with a Libor Market Model and simulating their evolution in a Monte Carlo framework.

This approach represents uncertainty in future forward rates and can be used to generate scenarios for later cash flows. The response is brief: it does not specify model calibration, measure choice, simulation details, or how to convert simulated rates into the expected payment. Those choices matter for a rigorous valuation, so the suggestion identifies a framework rather than a complete estimation procedure.

Key ideas

  • A later floating swap payment depends on a forward rate that has not yet reset.
  • A Libor Market Model can represent the evolution of forward rates.
  • Monte Carlo simulation can generate future rate scenarios for estimating cash flows.
  • The model requires further choices, including calibration and the valuation measure.

Tags

Fixed incomeDerivatives pricingStatistics
Full text
# What is mathematically rigorous way to estimate floating swap cash flow in the future?


# What is mathematically rigorous way to estimate floating swap cash flow in the future?












In vanilla swap, the FL payments is fixed on one date and paid on the next reset date. So the next payment is known. However, the payment after that is not known. What would be the best estimate of that, mathematically?

Applying Markov property to bond price, expected price will not change. Calculate next to next payment from the next known payment along with forward rate at the next reset period. It seems to be simple.

I am looking for a more mathematically correct way to approach this, if any.

## Answer by salisboss (score -1)

https://quant.stackexchange.com/a/21948

You could model the forward Libor Rates using Libor Market Model in a Monte Carlo setting to get the Libor behavior in the future.

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