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Savvysoft Releases Market’s First Recombining Tree-Based Multi-Factor Libor Market Model

Faster and more accurate than existing Monte Carlo methods with no calibration required

New York – November 5, 2007 – Savvysoft, the award-winning maker of derivatives software, today announced the market’s first offering of a multi-factor interest rate model that uses recombining trees for valuation. All other implementations in the market of the popular Libor Market Model (also known as BGM), are based on Monte Carlo simulation. Savvysoft is the only vendor offering a recombining tree.

“This is an important development in the interest rate derivatives market, since Monte Carlo solutions are slow, unable to reliably handle American and Bermudan options, and are very difficult to use for hedging and performance measurement,” said Rich Tanenbaum, Savvysoft founder, and developer of the new model. “Trees don’t suffer from any of these shortcomings, and are fast enough to use for large portfolio analytics. We’re extremely excited about being able to offer this brand-new technology.”

Binomial trees are the market standard for pricing derivative instruments in many markets, but until now they have not been viable for the Libor Market Model, since they previously required non-recombining, or bushy, trees. The trees in Savvysoft’s new model are recombining, which means that when considering possible paths of future interest rate moves, a down day followed by an up day leaves the market (and the tree) in the same place as an up day followed by a down day. Trees that don’t have this property, and don’t recombine, grow exponentially in size, and quickly use up the storage capacity of the computer, and take much too long to calculate. Recombining trees offer the most efficient way to deal with American and Bermudan options. For a typical problem, a non-recombining tree might take 4 months to calculate an option value, but with Savvysoft’s new model that time would be reduced to 7 seconds.

Savvysoft’s model is the first to offer recombining trees with more than one factor. In fact, Savvysoft’s models can handle as many factors as the user wishes. Whereas a one-factor model is equivalent to allowing the yield curve to move up or down in parallel, a two-factor model also allows for changes in slope, and a three-factor model forecasts changes in the curvature of the yield curve, as well. Many complex derivative structures require multi-factor models, and Savvysoft’s new LMM implementation is the only one that can price and hedge these efficiently and accurately.

As with other LMM models, Savvysoft’s is able to calibrate to both the swaption and the cap market. However, Savvysoft has also devised a new method for extracting the correlation of all the points on the yield curve with each other, requiring the user to supply only the cap and swaption volatility surfaces, which are readily available. The calibration is exact, which means that the model does not make a best-fit guess at volatility, as other implementations do. Rather than selecting from a myriad of optimization choices which produce different (and therefore inaccurate) results, the calibration in Savvysoft’s model is exact. This makes Savvysoft’s new model much easier to use than competing products. Simply pass the model the yield curve, the volatility surface (or cube, with skew), and the model calculates the rest.

Savvysoft’s model also allows the user to price derivatives using a blend of normal and lognormal interest rates processes, as in the constant elasticity of variance model (CEV). This helps to capture smiles and skews in the market.

Savvysoft’s new Libor Market Model is part of Savvysoft’s award-winning TOPS suite of derivatives analytics. The model may be used inside Savvysoft’s STARS portfolio management system, or plugged into other open systems. Savvysoft has been voted the number one ranked derivatives analytics vendor three years in a row in customer satisfaction surveys by Risk and Euromoney magazines.

About Savvysoft

Savvysoft is a New York City-based provider of high-caliber OTC derivatives analytics, and portfolio and risk management systems. Savvysoft’s products handle OTC derivatives in every traded market, and are used by thousands of institutions in 15 countries worldwide. These institutions include top-tier banks, dealers, brokers, money managers, energy suppliers, corporate treasurers, auditors and consultants. Savvysoft was founded by Rich Tanenbaum, the head of Derivatives Research at Bankers Trust (now Deutsche Bank). Rich was a founding member of the first OTC derivatives desk on Wall Street at Bankers Trust.

All product names referenced herein are trademarks of their respective companies.

Contact: LeeAnn Chen (212) 742-8677 leeann@savvysoft.com

 

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