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Pricing Cms Spread Options In A Libor Market Model

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Author Info

  • DENIS BELOMESTNY

    ()
    (Weierstrass Institute for Applied Analysis and Stochastics, Mohrenstr. 39, 10117, Berlin, Germany)

  • ANASTASIA KOLODKO

    ()
    (Weierstrass Institute for Applied Analysis and Stochastics, Mohrenstr. 39, 10117, Berlin, Germany)

  • JOHN SCHOENMAKERS

    ()
    (Weierstrass Institute for Applied Analysis and Stochastics, Mohrenstr. 39, 10117, Berlin, Germany)

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    Abstract

    We present two approximation methods for the pricing of CMS spread options in Libor market models. Both approaches are based on approximating the underlying swap rates with lognormal processes under suitable measures. The first method is derived straightforwardly from the Libor market model. The second one uses a convexity adjustment technique under a linear swap model assumption. A numerical study demonstrates that both methods provide satisfactory approximations of spread option prices and can be used for calibration of a Libor market model to the CMS spread option market.

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    Bibliographic Info

    Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance.

    Volume (Year): 13 (2010)
    Issue (Month): 01 ()
    Pages: 45-62

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    Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:01:p:45-62

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    Related research

    Keywords: CMS spread option; Margrabes formula; Libor market model;

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