Pricing Interest Rate Derivatives in a Multifactor HJM Model with Time
We investigate the partial differential equation (PDE) for pricing interest derivatives in the multi-factor Cheyette Model, which involves time-dependent volatility functions with a special structure. The high dimensional parabolic PDE that results is solved numerically via a modified sparse grid approach, that turns out to be accurate and efficient. In addition we study the corresponding Monte Carlo simulation, which is fast since the distribution of the state variables can be calculated explicitly. The results obtained from both methodologies are compared to the known analytical solutions for bonds and caplets. When there is no analytical solution, both European and Bermudan swaptions have been evaluated using the sparse grid PDE approach that is shown to outperform the Monte Carlo simulation.
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| Length: | 65 pages |
| Date of creation: | 01 Oct 2012 |
| Handle: | RePEc:uts:rpaper:317 |
| Contact details of provider: | Postal: PO Box 123, Broadway, NSW 2007, Australia Phone: +61 2 9514 7777 Fax: +61 2 9514 7711 Web page: http://www.qfrc.uts.edu.au/ More information through EDIRC
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References listed on IDEAS
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- Tomas Björk & Yuri Kabanov & Wolfgang Runggaldier, 1997. "Bond Market Structure in the Presence of Marked Point Processes," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 211-239.
- R. Bhar & C. Chiarella, 1997.
"Transformation of Heath?Jarrow?Morton models to Markovian systems,"
The European Journal of Finance,
Taylor & Francis Journals, vol. 3(1), pages 1-26.
- Ram Bhar & Carl Chiarella, 1995. "Transformation of Heath-Jarrow-Morton Models to Markovian Systems," Working Paper Series 53, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
- Marc Henrard, 2003. "Explicit bond option and swaption formula in Heath-Jarrow-Morton one factor model," Finance 0310009, EconWPA.
- Robert A. Jarrow, 2009. "The Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 69-96, November. Full references (including those not matched with items on IDEAS)
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