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Notes on convexity and quanto adjustments for interest rates and related options

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  • Boenkost, Wolfram
  • Schmidt, Wolfgang M.
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    Abstract

    We collect simple and pragmatic exact formulae for the convexity adjustment of irregular interest rate cash flows as Libor-in-arrears or payments of a swap rate (CMS rate) at an irregular date. The results are compared with the results of an approximative approach available in the popular literature. For options on Libor-in-arrears or CMS rates like caps or binaries we derive an additional new convexity adjustment for the volatility to be used in a standard Black & Scholes model. We study the quality of the adjustments comparing the results of the approximative Black & Scholes formula with the results of an exact valuation formula. Further we investigate options to exchange interest rates which are possibly set at different dates or admit different tenors. We collect general quanto adjustments formulae for variable interest rates to be paid in foreign currency and derive valuation formulae for standard options on interest rates paid in foreign currency. --

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    Bibliographic Info

    Paper provided by Frankfurt School of Finance and Management in its series Frankfurt School - Working Paper Series with number 47.

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    Date of creation: 2003
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    Handle: RePEc:zbw:fsfmwp:47

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    Related research

    Keywords: interest rate options; convexity; quanto adjustment; change of numeraire;

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    1. Cremers, Heinz, 2000. "Konvergenz der binomialen Optionspreismodelle gegen das Modell von Black/Scholes/Merton," Frankfurt School - Working Paper Series 26, Frankfurt School of Finance and Management.
    2. Moormann, Jürgen, 2002. "Terminologie und Glossar der Bankinformatik," Frankfurt School - Working Paper Series 37, Frankfurt School of Finance and Management.
    3. Wolf, Birgit, 2000. "Die Eigenmittelkonzeption des § 10 KWG," Frankfurt School - Working Paper Series 20, Frankfurt School of Finance and Management.
    4. Ecker, Thomas & Moormann, Jürgen, 1997. "Die Bank als Betreiberin einer elektronischen Shopping-Mall," Frankfurt School - Working Paper Series 4, Frankfurt School of Finance and Management.
    5. Jochum, Eduard, 1999. "Hoshin Kanri: management by policy (MbP)," Frankfurt School - Working Paper Series 14, Frankfurt School of Finance and Management.
    6. Biswas, Rita & Löchel, Horst, 2001. "Recent trends in U.S. and German banking: convergence or divergence?," Frankfurt School - Working Paper Series 29, Frankfurt School of Finance and Management.
    7. Moormann, Jürgen & Frank, Axel, 2000. "Grenzen des Outsourcing: eine Exploration am Beispiel von Direktbanken," Frankfurt School - Working Paper Series 24, Frankfurt School of Finance and Management.
    8. Heidorn, Thomas, 2001. "Bewertung von Kreditprodukten und Credit Default Swaps," Frankfurt School - Working Paper Series 36, Frankfurt School of Finance and Management.
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    Cited by:
    1. Harhoff, Dietmar & Mueller, Elisabeth & Van Reenen, John, 2012. "What are the channels for technology sourcing? Panel data evidence from German companies," Frankfurt School - Working Paper Series 187, Frankfurt School of Finance and Management.
    2. Yu, Xiaofan, 2011. "A spatial interpretation of the persistency of China's provincial inequality," Frankfurt School - Working Paper Series 171, Frankfurt School of Finance and Management.
    3. Böing, Philipp & Müller, Elisabeth, 2012. "Technological Capabilities of Chinese Enterprises: Who is Going to Compete Abroad?," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62081, Verein für Socialpolitik / German Economic Association.
    4. Inklaar, Robert & Koetter, Michael & Noth, Felix, 2012. "Who's afraid of big bad banks? Bank competition, SME, and industry growth," Frankfurt School - Working Paper Series 197, Frankfurt School of Finance and Management.
    5. Libman, Alexander & Kozlov, Vladimir & Schultz, André, 2012. "Roving bandits in action: Outside option and governmental predation in autocracies," Frankfurt School - Working Paper Series 190, Frankfurt School of Finance and Management.
    6. Boeing, Philipp & Mueller, Elisabeth & Sandner, Philipp, 2012. "What makes Chinese firms productive? Learning from indigenous and foreign sources of knowledge," Frankfurt School - Working Paper Series 196, Frankfurt School of Finance and Management.

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