CMS Swaps and Caps in One-Factor Gaussian Models
9 Pages Posted: 14 May 2007 Last revised: 12 Feb 2008
Date Written: 1 February 2008
An approximation approach to Constant Maturity Swaps (CMS) pricing in the separable one-factor Gaussian LMM and HJM models is presented. The approximation used is a Taylor expansion on the swap rate as a function of a random variable which is intuitively similar to a (short) rate. This approach is different from the standard approach in CMS where the discounting is written as a function of the swap rate. The approximation is very efficient. A similar approach can be used to price CMS caps and floors.
Keywords: CMS, CMS caps, Libor Market Model, Bond Market Model, one factor, separability, approximation
JEL Classification: G13, E43, C63
Suggested Citation: Suggested Citation