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Calibration of one-factor and two-factor Hull–White models using swaptions

Author

Listed:
  • Vincenzo Russo

    (Assicurazioni Generali S.p.A.)

  • Gabriele Torri

    (University of Bergamo
    VŠB-TU Ostrava)

Abstract

In this paper, we analize a novel approach for calibrating the one-factor and the two-factor Hull–White models using swaptions under a market-consistent framework. The technique is based on the pricing formulas for coupon bond options and swaptions proposed by Russo and Fabozzi (J Fixed Income 25:76–82, 2016b; J Fixed Income 27:30–36, 2017b). Under this approach, the volatility of the coupon bond is derived as a function of the stochastic durations. Consequently, the price of coupon bond options and swaptions can be calculated by simply applying standard no-arbitrage pricing theory given the equivalence between the price of a coupon bond option and the price of the corresponding swaption. This approach can be adopted to calibrate parameters of the one-factor and the two-factor Hull–White models using swaptions quoted in the market. It represents an alternative with respect to the existing approaches proposed in the literature and currently used by practitioners. Numerical analyses are provided in order to highlight the quality of the calibration results in comparison with existing models, addressing some computational issues related to the optimization model. In particular, calibration results and sensitivities are provided for the one- and the two-factor models using market data from 2011 to 2016. Finally, an out-of-sample analysis is performed in order to test the ability of the model in fitting swaption prices different from those used in the calibration process.

Suggested Citation

  • Vincenzo Russo & Gabriele Torri, 2019. "Calibration of one-factor and two-factor Hull–White models using swaptions," Computational Management Science, Springer, vol. 16(1), pages 275-295, February.
    • Handle: RePEc:spr:comgts:v:16:y:2019:i:1:d:10.1007_s10287-018-0323-z
    DOI: 10.1007/s10287-018-0323-z
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    References listed on IDEAS

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    1. David F. Schrager & Antoon A. J. Pelsser, 2006. "Pricing Swaptions And Coupon Bond Options In Affine Term Structure Models," Mathematical Finance, Wiley Blackwell, vol. 16(4), pages 673-694, October.
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    Cited by:

    1. Claudio Fontana & Francesco Rotondi, 2022. "Valuation of general GMWB annuities in a low interest rate environment," Papers 2208.10183, arXiv.org, revised Aug 2023.
    2. Fontana, Claudio & Rotondi, Francesco, 2023. "Valuation of general GMWB annuities in a low interest rate environment," Insurance: Mathematics and Economics, Elsevier, vol. 112(C), pages 142-167.
    3. Kladívko, Kamil & Rusý, Tomáš, 2023. "Maximum likelihood estimation of the Hull–White model," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 227-247.

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