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Pricing range notes within Wishart affine models

Author

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  • Chiarella, Carl
  • Da Fonseca, José
  • Grasselli, Martino

Abstract

We provide analytic pricing formulas for Fixed and Floating Range Accrual Notes within the multifactor Wishart affine framework which extends significantly the standard affine model. Using estimates for three short rate models, two of which are based on the Wishart process whilst the third one belongs to the standard affine framework, we price these structured products using the FFT methodology. Thanks to the Wishart tractability the hedge ratios are also easily computed. As the models are estimated on the same dataset, our results illustrate how the fit discrepancies (meaning differences in the likelihood functions) between models translate in terms of derivatives pricing errors, and we show that the models can produce different price evolutions for the Range Accrual Notes. The differences can be substantial and underline the importance of model risk both from a static and a dynamic perspective. These results are confirmed by an analysis performed at the hedge ratios level.

Suggested Citation

  • Chiarella, Carl & Da Fonseca, José & Grasselli, Martino, 2014. "Pricing range notes within Wishart affine models," Insurance: Mathematics and Economics, Elsevier, vol. 58(C), pages 193-203.
  • Handle: RePEc:eee:insuma:v:58:y:2014:i:c:p:193-203
    DOI: 10.1016/j.insmatheco.2014.07.008
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    References listed on IDEAS

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    Cited by:

    1. Deelstra, Griselda & Grasselli, Martino & Van Weverberg, Christopher, 2016. "The role of the dependence between mortality and interest rates when pricing Guaranteed Annuity Options," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 205-219.

    More about this item

    Keywords

    Term structure models; Wishart models; Range accrual notes;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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