IDEAS home Printed from https://ideas.repec.org/a/taf/apmtfi/v12y2005i2p121-146.html
   My bibliography  Save this article

Pricing Quanto Equity Swaps in a Stochastic Interest Rate Economy

Author

Listed:
  • San-Lin Chung
  • Hsiao-Fen Yang

Abstract

This paper derives a pricing model for a quanto foreign equity/domestic floating rate swap in which one party pays domestic floating interest rates and receives foreign stock returns determined in the foreign currency, but is paid in the domestic currency. We use the risk-neutral valuation technique developed by Amin and Bodurtha to generate an arbitrage-free pricing model. A closed-form solution is obtained under further restrictions on the drift rates of the asset price processes. Pricing formulae show that the value of a quanto equity swap at the start date does not depend on the foreign stock price level, but rather on the term structures of both countries and other parameters. However, the foreign stock price levels do affect the swap value times between two payment dates. The numerical implementations indicate that the domestic and foreign term structures, the correlation between the foreign interest rate and the exchange rate, and the correlation between the exchange rate and the foreign stock are more important factors in pricing a quanto equity swap than other correlations.

Suggested Citation

  • San-Lin Chung & Hsiao-Fen Yang, 2005. "Pricing Quanto Equity Swaps in a Stochastic Interest Rate Economy," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(2), pages 121-146.
    • Handle: RePEc:taf:apmtfi:v:12:y:2005:i:2:p:121-146
    DOI: 10.1080/1350486042000297261
    as

    Download full text from publisher

    File URL: http://www.tandfonline.com/doi/abs/10.1080/1350486042000297261
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1080/1350486042000297261?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Heath, David & Jarrow, Robert & Morton, Andrew, 1990. "Bond Pricing and the Term Structure of Interest Rates: A Discrete Time Approximation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(4), pages 419-440, December.
    2. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
    3. Litzenberger, Robert H, 1992. "Swaps: Plain and Fanciful," Journal of Finance, American Finance Association, vol. 47(3), pages 831-850, July.
    4. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Manfred Fruhwirth & Paul Schneider & Markus S. Schwaiger, 2007. "Timing Decisions in a Multinational Context: Implementing the Amin/Bodurtha Framework," Multinational Finance Journal, Multinational Finance Journal, vol. 11(3-4), pages 157-178, September.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gupta, Anurag & Subrahmanyam, Marti G., 2000. "An empirical examination of the convexity bias in the pricing of interest rate swaps," Journal of Financial Economics, Elsevier, vol. 55(2), pages 239-279, February.
    2. Robert R. Bliss & Ehud I. Ronn, 1997. "Callable U.S. Treasury bonds: optimal calls, anomalies, and implied volatilities," FRB Atlanta Working Paper 97-1, Federal Reserve Bank of Atlanta.
    3. Fergusson, Kevin, 2020. "Less-Expensive Valuation And Reserving Of Long-Dated Variable Annuities When Interest Rates And Mortality Rates Are Stochastic," ASTIN Bulletin, Cambridge University Press, vol. 50(2), pages 381-417, May.
    4. repec:uts:finphd:40 is not listed on IDEAS
    5. Oldrich Alfons Vasicek & Francisco Venegas-Martínez, 2021. "Models of the Term Structure of Interest Rates: Review, Trends, and Perspectives," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 16(2), pages 1-28, Abril - J.
    6. Dwight Grant & Gautam Vora, 2006. "Extending the universality of the Heath–Jarrow–Morton model," Review of Financial Economics, John Wiley & Sons, vol. 15(2), pages 129-157.
    7. Duffie, Darrell, 2003. "Intertemporal asset pricing theory," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 11, pages 639-742, Elsevier.
    8. David Bolder, 2001. "Affine Term-Structure Models: Theory and Implementation," Staff Working Papers 01-15, Bank of Canada.
    9. João Pedro Vidal Nunes & Luís Alberto Ferreira De Oliveira, 2007. "Multifactor and analytical valuation of treasury bond futures with an embedded quality option," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 27(3), pages 275-303, March.
    10. repec:dau:papers:123456789/5374 is not listed on IDEAS
    11. Alexei Onatski & Slava Kargin, 2004. "Dynamics of Interest Rate Curve by Functional Auto-regression," Econometric Society 2004 North American Summer Meetings 229, Econometric Society.
    12. Stoyan Valchev, 2004. "Stochastic volatility Gaussian Heath-Jarrow-Morton models," Applied Mathematical Finance, Taylor & Francis Journals, vol. 11(4), pages 347-368.
    13. Kevin John Fergusson, 2018. "Less-Expensive Pricing and Hedging of Extreme-Maturity Interest Rate Derivatives and Equity Index Options Under the Real-World Measure," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 3-2018.
    14. Jirô Akahori & Hiroki Aoki & Yoshihiko Nagata, 2006. "Generalizations of Ho–Lee’s binomial interest rate model I: from one- to multi-factor," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 13(2), pages 151-179, June.
    15. Carlo Mari & Roberto Reno, 2006. "Arbitrary Initial Term Structure within the CIR Model: A Perturbative Solution," Applied Mathematical Finance, Taylor & Francis Journals, vol. 13(2), pages 143-153.
    16. Oldrich Alfons Vasicek & Francisco Venegas-Martínez, 2021. "Modelos de la estructura de plazos de las tasas de interés: Revisión, tendencias y perspectivas," Remef - Revista Mexicana de Economía y Finanzas Nueva Época REMEF (The Mexican Journal of Economics and Finance), Instituto Mexicano de Ejecutivos de Finanzas, IMEF, vol. 16(2), pages 1-28, Abril - J.
    17. Josheski Dushko & Apostolov Mico, 2021. "Equilibrium Short-Rate Models Vs No-Arbitrage Models: Literature Review and Computational Examples," Econometrics. Advances in Applied Data Analysis, Sciendo, vol. 25(3), pages 42-71, September.
    18. Driessen, Joost & Klaassen, Pieter & Melenberg, Bertrand, 2003. "The Performance of Multi-Factor Term Structure Models for Pricing and Hedging Caps and Swaptions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(3), pages 635-672, September.
    19. Raj, Mahendra & Sim, Ah Boon & Thurston, David C., 1997. "A generalized method of moments comparison of the cox-ingersoll-ross and heath-jarrow-morton models," Journal of Economics and Business, Elsevier, vol. 49(2), pages 169-192.
    20. Carl Chiarella & Xue-Zhong He & Christina Sklibosios Nikitopoulos, 2015. "Derivative Security Pricing," Dynamic Modeling and Econometrics in Economics and Finance, Springer, edition 127, number 978-3-662-45906-5, July-Dece.
    21. Kuo, I-Doun & Lin, Yueh-Neng, 2009. "Empirical performance of multifactor term structure models for pricing and hedging Eurodollar futures options," Review of Financial Economics, Elsevier, vol. 18(1), pages 23-32, January.
    22. Grant, Dwight & Vora, Gautam, 2006. "Extending the universality of the Heath-Jarrow-Morton model," Review of Financial Economics, Elsevier, vol. 15(2), pages 129-157.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:apmtfi:v:12:y:2005:i:2:p:121-146. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Longhurst (email available below). General contact details of provider: http://www.tandfonline.com/RAMF20 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.