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Option Valuation in Multivariate SABR Models


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  • Jörg Kienitz

    (Deutsche Postbank AG)

  • Manuel Wittke

    (University of Bonn)

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    We consider the joint dynamic of a basket of n-assets where each asset itself follows a SABR stochastic volatility model. Using the Markovian Projection methodology we approximate a univariate displaced diffusion SABR dynamic for the basket to price caps and floors in closed form. This enables us to consider not only the asset correlation but also the skew, the cross-skew and the decorrelation in our approximation. The latter is not possible in alternative approximations to price e.g. spread options. We illustrate the method by considering the example where the underlyings are two constant maturity swap (CMS) rates. Here we examine the influence of the swaption volatility cube on CMS spread options and compare our approximation formulae to results obtained by Monte Carlo simulation and a copula approach.

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    Bibliographic Info

    Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 272.

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    Length: 26
    Date of creation: 01 Feb 2010
    Date of revision:
    Handle: RePEc:uts:rpaper:272

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    Related research

    Keywords: SABR; CMS spread; displaced diffusion; Markovian projection; GyÄongy Lemma;

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