Calibration of Interest Rate Models - Transition Market Case

A methodology to calibrate multifactor interest rate model for transition countries is proposed. The usual methodology of calibration with implied volatility cannot be used as there are no markets for regularly traded derivatives. The existence of such a markets is essential for this calibration. The paradigm used is the Brace-Gatarek-Musiela model of interest rates (Brace, Gatarek and Musiela (1997)), which models the evolution of LIBOR (London InterBank Offered Rate) market interest rates, together with the Orthogonal GARCH model proposed by Alexander (2002), and further generalized by van der Weide (2002). The estimated model is used for the analysis of interest rate markets with shorter-end maturities in the 4 Visegrad countries (Slovak Republic, Czech Republic, Poland and Hungary).