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Cash-Settled Swaptions: A New Pricing Model

Author

Listed:
  • RAOUL PIETERSZ

    (ABN AMRO Bank N.V., Gustav Mahlerlaan 10, 1082 PP Amsterdam, The Netherlands)

  • FRANK SENGERS

    (ABN AMRO Bank N.V., Gustav Mahlerlaan 10, 1082 PP Amsterdam, The Netherlands)

  • MATTEO MICHIELON

    (ABN AMRO Bank N.V., Gustav Mahlerlaan 10, 1082 PP Amsterdam, The Netherlands)

Abstract

The market for cash-settled swaptions has changed its quotation conventions. Cash-settled zero-wide collars struck at the swap-settled forward have started trading at nonzero prices. Apart from full-fledged term-structure models, a simple arbitrage-free model to consistently value both cash-settled and swap-settled swaptions has been lacking so far. We propose a straightforward arbitrage-free model that consistently values cash-settled and swap-settled swaptions, and that also allows one to match zero-wide collar premiums. The defining characteristic of the model is to explicitly specify the swap-settled annuity as a function of a discount swap rate under the swap-settled annuity measure. The new methodology has many desirable features, and we show via a numerical example how the model performs in realistic market scenarios.

Suggested Citation

  • Raoul Pietersz & Frank Sengers & Matteo Michielon, 2020. "Cash-Settled Swaptions: A New Pricing Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 23(04), pages 1-16, June.
    • Handle: RePEc:wsi:ijtafx:v:23:y:2020:i:04:n:s0219024920500284
    DOI: 10.1142/S0219024920500284
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