LIBOR Market Model

An interest rate model based on evolving LIBOR market forward rates. The objects modeled using LMM are market-observable quantities (LIBOR forward rates). The LIBOR Market Model can be used to price any instrument whose pay-off can be decomposed into a set of forward rates. It assumes that the evolution of each forward rate is lognormal. Each forward rate has a time dependent volatility and time dependent correlations with the other forward rates being evolved. After specifying these volatilities and correlations, an instrument can be priced using Monte Carlo simulation to evolve the forward rates.