Pricing Range Notes within Wishart Affine Models
36 Pages Posted: 11 Aug 2013 Last revised: 4 Jan 2014
Date Written: January 3, 2014
We provide analytic pricing formulas for Fixed and Floating Range Accrual Notes within the multi-factor Wishart affine framework which extends significantly the standard affine model. Using estimates for three short rate models, two of which are based on the Wishart process whilst the third one belongs to the standard affine framework, we price these structured products using the FFT methodology. Thanks to the Wishart tractability the hedge ratios are also easily computed. As the models are estimated on the same data-set, our results illustrate how the fit discrepancies (meaning differences in the likelihood functions) between models translate in terms of derivatives pricing errors, and we show that the models can produce different price evolutions for the Range Accrual Notes. The differences can be substantial and underline the importance of model risk both from a static and dynamic perspective. These results are confirmed by an analysis performed at the hedge ratios level.
Keywords: affine term structure models, Wishart models, Range Accrual Notes, model risk
JEL Classification: C63, G13
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