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How to calibrate Gaussian two-factor model using swaption

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  • Myeongsu Choi
  • Hyoung-Goo Kang

Abstract

We propose an efficient approximation of the swaption normal volatility to estimate the mean reversion separately from the other volatility parameters in the Gaussian two-factor model. We compare our two-step approach with a one-step method that calibrates all parameters simultaneously. The comparison is based on the data from interest rate market of Korea and the US. The parameter estimates of our proposed two-step method are more stable than those of the one-step method in that the latter is overly sensitive to market changes whereas the former is not. The proposed approach also eliminates many existing problems in the Gaussian two-factor model.

Suggested Citation

  • Myeongsu Choi & Hyoung-Goo Kang, 2023. "How to calibrate Gaussian two-factor model using swaption," PLOS ONE, Public Library of Science, vol. 18(2), pages 1-21, February.
    • Handle: RePEc:plo:pone00:0280829
    DOI: 10.1371/journal.pone.0280829
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