Control Variates for Callable LIBOR Exotics - A Preliminary Study

Proceedings of the 5th Actuarial and Financial Mathematics Day, M. Vanmaele et al, eds, Brussels

11 Pages Posted: 28 Oct 2008

See all articles by Jacob Buitelaar

Jacob Buitelaar

Goldman Sachs International

Roger Lord

Cardano Risk Management

Date Written: March 26, 2007

Abstract

Monte Carlo simulation is currently the method of choice for the pricing of callable derivatives in LIBOR market models. Lately more and more papers are surfacing in which variance reduction methods are applied to the pricing of derivatives with early exercise features. We focus on one of the conceptually easiest variance reduction methods, control variates. The basis of our method is an upper bound of the callable contract in terms of plain vanilla contracts, which is found to be a highly effective control variate. Several examples of callable LIBOR exotics demonstrate the effectiveness and wide applicability of the method.

Keywords: LIBOR market model, variance reduction, control variates, Monte Carlo, Bermudans, callable derivatives, Longstaff-Schwartz

JEL Classification: C15, C63, G13

Suggested Citation

Buitelaar, Jacob and Lord, Roger, Control Variates for Callable LIBOR Exotics - A Preliminary Study (March 26, 2007). Proceedings of the 5th Actuarial and Financial Mathematics Day, M. Vanmaele et al, eds, Brussels, Available at SSRN: https://ssrn.com/abstract=1288686 or http://dx.doi.org/10.2139/ssrn.1288686

Jacob Buitelaar

Goldman Sachs International ( email )

United Kingdom

Roger Lord (Contact Author)

Cardano Risk Management ( email )

Rotterdam 3011 AA
Netherlands

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