
Swap Rate a la Stock: Bermudan Swaptions Made Easy
Online
Wednesday 9th September 2020
6:00pm - 7:30pm
This talk shows how Markovian projection together with some clever parameter freezing can be used to reduce a full-edged local volatility interest rate model – such as Cheyette (1992) – to a ”minimal” form in which the swap rate evolves essentially like a dividend-paying stock. This talk will compare such a minimal “poor man’s” model to a full-edged Cheyette local volatility model and the market benchmark Hull-White onefactor model. Numerical tests demonstrate that the “poor man’s” model is in fact sufficient to price Bermudan interest rate swaptions. The main practical implication of this finding is that – once local volatility; dividend and short rate parameters are properly stripped from the volatility surface and interest rate curve – one can readily use the widely popular equity derivatives software for pricing exotic interest rate options such as Bermudans.
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