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research article

On the American swaption in the linear-rational framework

Filipović, Damir
•
Kitapbayev, Yerkin
April 24, 2018
Quantitative Finance

We study American swaptions in the linear-rational (LR) term structure model introduced in Filipović et al. [J. Finance., 2017, 72, 655–704]. The American swaption pricing problem boils down to an optimal stopping problem that is analytically tractable. It reduces to a free-boundary problem that we tackle by the local time-space calculus of Peskir [J. Theoret. Probab., 2005a, 18, 499–535]. We characterize the optimal stopping boundary as the unique solution to a non-linear integral equation that can be readily solved numerically. We obtain the arbitrage-free price of the American swaption and the optimal exercise strategies in terms of swap rates for both fixed-rate payer and receiver swaps. Finally, we show that Bermudan swaptions can be efficiently priced as well.

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Type
research article
DOI
10.1080/14697688.2018.1446547
Author(s)
Filipović, Damir
Kitapbayev, Yerkin
Date Issued

2018-04-24

Published in
Quantitative Finance
Start page

1

End page

12

Subjects

American swaption

•

Free-boundary problem

•

Integral equation

•

Linear-rational term structure model

•

Local time

•

Optimal stopping

•

Swap

•

Swaption

URL

Quantitative Finance

https://www.tandfonline.com/doi/full/10.1080/14697688.2018.1446547
Editorial or Peer reviewed

REVIEWED

Written at

EPFL

EPFL units
CSF  
Available on Infoscience
October 15, 2018
Use this identifier to reference this record
https://infoscience.epfl.ch/handle/20.500.14299/148826
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