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Pricing Cms Spread Options In A Libor Market Model

Author

Listed:
  • DENIS BELOMESTNY

    (Weierstrass Institute for Applied Analysis and Stochastics, Mohrenstr. 39, 10117, Berlin, Germany)

  • ANASTASIA KOLODKO

    (Weierstrass Institute for Applied Analysis and Stochastics, Mohrenstr. 39, 10117, Berlin, Germany)

  • JOHN SCHOENMAKERS

    (Weierstrass Institute for Applied Analysis and Stochastics, Mohrenstr. 39, 10117, Berlin, Germany)

Abstract

We present two approximation methods for the pricing of CMS spread options in Libor market models. Both approaches are based on approximating the underlying swap rates with lognormal processes under suitable measures. The first method is derived straightforwardly from the Libor market model. The second one uses a convexity adjustment technique under a linear swap model assumption. A numerical study demonstrates that both methods provide satisfactory approximations of spread option prices and can be used for calibration of a Libor market model to the CMS spread option market.

Suggested Citation

  • Denis Belomestny & Anastasia Kolodko & John Schoenmakers, 2010. "Pricing Cms Spread Options In A Libor Market Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 13(01), pages 45-62.
    • Handle: RePEc:wsi:ijtafx:v:13:y:2010:i:01:n:s021902491000567x
    DOI: 10.1142/S021902491000567X
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    References listed on IDEAS

    as
    1. Boenkost, Wolfram & Schmidt, Wolfgang M., 2003. "Notes on convexity and quanto adjustments for interest rates and related options," Frankfurt School - Working Paper Series 47, Frankfurt School of Finance and Management.
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