Cash-settled swaptions and no-arbitrage

Fabio Mercurio
01 Feb 2008

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Cash-settled swaptions are the most actively traded swaptions in the European market. Their payout is obtained by replacing the classical annuity term with a single-factor one, where discounting is based on a unique interest rate, namely the underlying swap rate set at the option's maturity. This simplification serves the purpose of a swaption payout whose value at maturity can be set with no ambiguity. However, from the modelling point of view, some complications arise, to the extent that cash

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