Technical paper/Interest rates
Information of interest
The flow of information in financial markets on future liquidity risk generates the rise and fall of demand for default-free bonds. Here, Dorje Brody and Robyn Friedman present an approach to pricing these bonds and the associated derivatives, based on…
Delta and vega hedging in the SABR and LMM-SABR models
Riccardo Rebonato, Andrey Pogudin and Richard White examine the hedging performance of the SABR and LMM-SABR models using real market data. As a by-product, they gain indirect evidence about how well specified the two models are. The results are…
Delta and vega hedging in the SABR and LMM-SABR models
Riccardo Rebonato, Andrey Pogudin and Richard White examine the hedging performance of the SABR and LMM-SABR models using real market data. As a by-product, they gain indirect evidence about how well specified the two models are. The results are…
Valuing Tips bond futures with the Jarrow-Yildirim model
Hongming Huang and Yildiray Yildirim apply the Jarrow-Yildirim model to derive a closed-form solution for Treasury inflation-protected securities (Tips) futures. With the issuance of inflation-protected bonds and the impact of inflation on financial…
A bridge between mortgage TBA options and swaptions
Shijun Liu provides basis-point volatility option pricing formulas for swaptions and mortgage to-be-announced options that make direct comparison of volatilities easy and transparent across the two interest rate derivatives markets. Basis-point…
A bridge between mortgage TBA options and swaptions
Interest Rates
Combining the SABR and LMM models
Pierre Henry-Labordere analyses a stochastic volatility Libor market model that combines the SABR and Brace-Gatarek-Musiela (BGM) models in a natural way
A time-homogeneous, SABR-consistent extension of the LMM
Riccardo Rebonato proposes an extension of the Libor market model (LMM) that recovers the stochastic, alpha, beta, rho (SABR) caplet prices almost exactly for all strikes and maturities. The dynamics of the volatility are chosen so as to be consistent…
A time-homogeneous, SABR-consistent extension of the LMM
Riccardo Rebonato proposes an extension of the Libor market model (LMM) that recovers the SABR caplet prices almost exactly for all strikes and maturities. The dynamics of the volatility are chosen so as to be consistent across expiries, to be…
Modelling inflation
Lars Kjaergaard models inflation using a three-factor Gaussian method. This gives a simple description of derivatives linked to inflation and interest rates, and allows for fast evaluation. He then shows how the model can be calibrated
Calibrating and pricing with local volatility models
Cutting edge - Option pricing
Calibrating and pricing with embedded local volatility models
Consistently fitting vanilla option surfaces when pricing volatility derivatives such as Vix options or interest rate/equity hybrids is an important issue. Here, Yong Ren, Dilip Madan and Michael Qian Qian show how this can be accomplished, using a…
Modelling inflation
Lars Kjaergaard models inflation using a three-factor Gaussian method. This gives a simple description of derivatives linked to inflation and interest rates, and allows for fast evaluation. He then shows how the model can be calibrated
Modelling inflation
Lars Kjaergaard models inflation using a three-factor Gaussian method. This gives a simple description of derivatives linked to inflation and interest rates, and allows for fast evaluation. He then shows how the model can be calibrated
Valuing inflation futures contracts
In recent years, futures contracts written on inflation (specifically, on the ratio of the consumer price index (CPI) level at two different times) have been introduced. Working within the Jarrow & Yildirim (2003) model, John Crosby derives formulas for…
Excess yields in bond hedging
Litterman & Scheinkman (1991) showed that the term structure of interest rates is reliablymodelled by an affine three-factor model using principal component analysis. Such a modelis inconsistent with no arbitrage. Here, Haim Reisman and Gady Zohar derive…
Correlating market models
While swaption prices theoretically contain information on interest rate correlation, Bruce Choy, Tim Dun and Erik Schlögl argue that, for any practical purpose, this information cannot be extracted. Care must therefore be taken when pricing correlation…
Component proponents II
Christophe Pérignon and Christophe Villa propose a novel method of extracting the risk factors driving interest rates that allows both the covariance matrix of interest rates and the variances of the risk factors to vary through time. To illustrate the…
Swap vega in BGM: pitfalls and alternatives
Raoul Pietersz and Antoon PelsserPractitioners who are developing the Libor BGM model for risk management of a swap-based interest rate derivative be warned: for certain volatility functions the estimate of swap vega may be poor. This may occur for time…
Black smirks
Fei Zhou presents a simple stochastic volatility extension of the Black interest rate option pricing model widely used by traders. Using a perturbative expansion in volatility of volatility, he derives modified Black formulas that correctly fit the…
The stochastic volatility Libor market model
Interest rates
The relativity of volatility
Stress testing