Convexity adjustments in inflation-linked derivatives

Dorje Brody, John Crosby and Hongyun Li value several types of inflation-linked derivatives using a multi-factor version of the Hughston (1998) and Jarrow & Yildirim (2003) model. Expressions for the prices of zero-coupon inflation swaps with delayed payment and period-on-period inflation swaps with delayed payments are obtained in closed form by explicitly calculating the relevant convexity adjustments. These results are then applied to value limited price indexation swaps using Ryten's (2007) common-factor representation methodology

The market for inflation-linked derivatives has grown rapidly in recent years. Inflation is now regarded as an independent asset class. Actively traded inflation derivatives include standard zero-coupon inflation swaps, as well as more complicated products such as period-on-period inflation swaps (Mercurio, 2005), inflation caps (Mercurio, 2005), inflation swaptions (Kerkhof, 2005) and futures contracts written on inflation (Crosby, 2007).Dorje Brody is a reader in mathematics at Imperial

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