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Pricing Convexity Adjustment with Wiener Chaos

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  • Eric Benhamou

Abstract

This paper presents an approximated formula of the convexity adjustment of Constant Maturity Swap rates, using Wiener Chaos expansion, for multi-factor lognormal zero coupon models. We derive closed formulae for CMS bond and swap and apply results to various well-known one-factor models (Ho and Lee (1986), Amin and Jarrow (1992), Hull and White (1990), Mercurio and Moraleda (1996)). Quasi Monte Carlo simulations confirm the efficiency of the approximation.

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  • Eric Benhamou, 2000. "Pricing Convexity Adjustment with Wiener Chaos," FMG Discussion Papers dp351, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp351
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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp351.pdf
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    References listed on IDEAS

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    1. Fabio Mercurio & Juan M. Moraleda, 1996. "A Family of Humped Volatility Structures," Tinbergen Institute Discussion Papers 96-169/2, Tinbergen Institute.
    2. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
    3. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    5. Vincent Lacoste, 1996. "Wiener Chaos: A New Approach To Option Hedging," Mathematical Finance, Wiley Blackwell, vol. 6(2), pages 197-213.
    6. Eric Benhamou, 2002. "A Martingale Result for Convexity Adjustment in the Black Pricing Model," Finance 0212005, EconWPA.
    7. Ho, Thomas S Y & Lee, Sang-bin, 1986. " Term Structure Movements and Pricing Interest Rate Contingent Claims," Journal of Finance, American Finance Association, vol. 41(5), pages 1011-1029, December.
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    Cited by:

    1. Didier Kouokap Youmbi, 2012. "Yield to maturity modelling and a Monte Carlo Technique for pricing Derivatives on Constant Maturity Treasury (CMT) and Derivatives on forward Bonds," Papers 1204.4631, arXiv.org.
    2. Jiří Witzany, 2009. "Valuation of Convexity Related Interest Rate Derivatives," Prague Economic Papers, University of Economics, Prague, vol. 2009(4), pages 309-326.
    3. Leccadito, Arturo & Tunaru, Radu S. & Urga, Giovanni, 2015. "Trading strategies with implied forward credit default swap spreads," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 361-375.
    4. Eric Benhamou, 2002. "A Martingale Result for Convexity Adjustment in the Black Pricing Model," Finance 0212005, EconWPA.
    5. Nabyl Belgrade & Eric Benhamou & Etienne Koehler, 2004. "A market model for inflation," Cahiers de la Maison des Sciences Economiques b04050, Université Panthéon-Sorbonne (Paris 1).

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