Valuation of CMS Spread Options with Nonzero Strike Rates in the LIBOR Market Model

The main purpose of this article is to provide an approximate general pricing formula for CMS spread options that can handle the case of nonzero strike rates. A generalized lognormal distribution is used to approximate the distribution of the difference between two CMS rates. Pricing models for CMS...

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Bibliographic Details
Published in:The Journal of derivatives 2011-10, Vol.19 (1), p.41
Main Authors: Wu, Ting-Pin, Chen, Son-Nan
Format: Article
Language:English
Subjects:
Approximation
Comparative studies
Interest rate swaps
LIBOR
Monte Carlo simulation
Securities prices
Spread
Online Access:Get full text
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Summary:The main purpose of this article is to provide an approximate general pricing formula for CMS spread options that can handle the case of nonzero strike rates. A generalized lognormal distribution is used to approximate the distribution of the difference between two CMS rates. Pricing models for CMS spread options with nonzero strike rates are then derived under the multifactor LIBOR market model and also shown to be analytically tractable for practical implementation. The models are shown to be robustly accurate in comparison with Monte Carlo simulation. [PUBLICATION ABSTRACT]
ISSN:1074-1240
2168-8524
DOI:10.3905/jod.2011.19.1.041