Recent research in federated large language models (LLMs) has primarily focused on enabling clients to fine-tune their locally deployed homogeneous LLMs collaboratively or on transferring knowledge from server-based LLMs to small language models (SLMs) at downstream clients. However, a significant gap remains in the simultaneous mutual enhancement of both the server’s LLM and clients’ SLMs. To bridge this gap, we propose FedMKT, a parameter-efficient federated mutual knowledge transfer framework for large and small language models. This framework is designed to adaptively transfer knowledge from the server’s LLM to clients’ SLMs while concurrently enhancing the LLM with clients’ unique domain insights. We facilitate token alignment using minimum edit distance (MinED) and then selective mutual knowledge transfer between client-side SLMs and a server-side LLM, aiming to collectively enhance their performance. Through extensive experiments across three distinct scenarios, we evaluate the effectiveness of FedMKT by utilizing diverse public LLMs and SLMs on a variety of NLP text generation tasks. Empirical results demonstrate that FedMKT simultaneously boosts the performance of both LLMs and SLMs. Our code has been contributed to the FATE open-source project and is now publicly accessible at https://github.com/FederatedAI/FATE-LLM/tree/main/python/fate_llm/algo/fedmkt