Fast Swaption Pricing Under a Market Model with Stochastic Volatility

Wu, Lixin; Zhang, Fan

doi:10.2139/ssrn.744284

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Fast Swaption Pricing Under a Market Model with Stochastic Volatility

30 Pages Posted: 20 Jun 2005

See all articles by Lixin Wu

Lixin Wu

Hong Kong University of Science & Technology - Department of Mathematics

Fan Zhang

Peking University

Date Written: March 2005

Abstract

In this paper we study a LIBOR market model with a volatility multiplier, which follows a square-root process. This model captures downward volatility skews through using negative correlations between forward rates and the multiplier. Approximate pricing formula is developed for swaptions, and the formula is implemented via fast Fourier transform. Numerical results on pricing accuracy are presented, which support the approximations made in deriving the formula.

Keywords: LIBOR model, stochastic volatility, square-root process, swaptions, Fast Fourier transform (FFT)

JEL Classification: C51, C61

Suggested Citation: Suggested Citation

Wu, Lixin and Zhang, Fan, Fast Swaption Pricing Under a Market Model with Stochastic Volatility (March 2005). Available at SSRN: https://ssrn.com/abstract=744284 or http://dx.doi.org/10.2139/ssrn.744284