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Pricing a Bermudan Swaption with a Short Rate Lattice Method

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  • Yasuhiro Tamba

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    (Graduate School of Economics, Osaka University)

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    Abstract

    This paper presents the tree construction approach to pricing a Bermudan swaption. The Bermudan swaption is an option, which at each date in a schedule of exercise dates gives the holder the right to enter an interest swap, provided that this right has not been exercised at any previous time in the schedule. Assuming a common diffusion short rate dynamics, the Hull-White model, we propose a dynamic programming approach for their risk neutral evaluation. This framework is suited to a calibration from an observed initial yield curve and market price data of discount bonds and European swaptions.

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    File URL: http://www2.econ.osaka-u.ac.jp/library/global/dp/0503.pdf
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    Bibliographic Info

    Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 05-03.

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    Length: 25 pages
    Date of creation: Mar 2005
    Date of revision:
    Handle: RePEc:osk:wpaper:0503

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    Web page: http://www.econ.osaka-u.ac.jp/
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    Keywords: Bermudan swaption; swap rate; risk neutral evaluation; dynamic programming; Hull-White model; calibration.;

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    1. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-47.
    2. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-92.
    3. Broadie, Mark & Glasserman, Paul, 1997. "Pricing American-style securities using simulation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 21(8-9), pages 1323-1352, June.
    4. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt43n1k4jb, Anderson Graduate School of Management, UCLA.
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