Inflation-indexed swaps and swaptions

This article considers the pricing and hedging of inflation-indexed swaps, and the pricing of inflation-indexed swaptions, and options on inflation-indexed bonds. To price the inflation-indexed swaps, we suggest an extended HJM model. The model allows both the forward rates and the consumer price in...

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Bibliographic Details
Published in:Journal of banking & finance 2008-11, Vol.32 (11), p.2293-2306
Main Author: Hinnerich, Mia
Format: Article
Language:English
Subjects:
Asset pricing
Bonds
Derivatives
Financial engineering
Hedging
Inflation
Inflation Index-linked Derivatives Swaps Swaptions Analogy
Option pricing
Options markets
Securities prices
Studies
Swap arrangements
Swaps
Translation Studies
översättningsvetenskap
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Summary:This article considers the pricing and hedging of inflation-indexed swaps, and the pricing of inflation-indexed swaptions, and options on inflation-indexed bonds. To price the inflation-indexed swaps, we suggest an extended HJM model. The model allows both the forward rates and the consumer price index to be driven, not only by a standard multidimensional Wiener process but also by a general marked point process. Our model is an extension of the HJM approach proposed by Jarrow and Yildirim [Jarrow, R., Yildirim, Y., 2003. Pricing treasury inflation protected securities and related derivatives using an HJM model. Journal of Financial and Quantitative Analysis 38, 409-430] and later also used by Mercurio [Mercurio, F., 2005. Pricing inflation-indexed derivatives. Quantitative Finance 5 (3), 289-302] to price inflation-indexed swaps. Furthermore we price options on so called TIPS-bonds assuming the model is purely Wiener driven. We then introduce an inflation swap market model to price inflation-indexed swaptions. All prices derived have explicit closed-form solutions. Furthermore, we formally prove the validity of the so called foreign-currency analogy.
ISSN:0378-4266
1872-6372
1872-6372
DOI:10.1016/j.jbankfin.2007.04.033