Efficient Control Variates and Strategies for Bermudan Swaptions in a Libor Market Model

Malene Shin Jensen () and Mikkel Svenstrup ()
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Malene Shin Jensen: Department of Management, University of Aarhus, Postal: Bartholins Alle, bygning 322, Universitetsparken, 8000 Århus C, Denmark
Mikkel Svenstrup: Department of Finance, Aarhus School of Business, Postal: Fuglesangs Allé 4, 8210 Aarhus V, Denmark

No 02-23, Finance Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies

Abstract: This paper concerns the problem of valuing Bermudan swaptions in

a Libor market model. In particular we consider various efficiency improvement

techniques for a Monte Carlo based valuation method. We

suggest a simplification of the Andersen (2000) exercise strategy and find

it to be much more efficient. Furthermore, we test a range of control

variates for Bermudan swaptions using a control variate technique for

American options proposed in Rasmussen (2002). Application of these

efficiency improvements in the Primal-Dual simulation algorithm of Andersen

& Broadie (2001) improves both upper and lower bounds for the

price estimates. For the Primal-Dual simulation algorithm we examine

the variance-bias trade-off between the numbers of outer an inner paths.

Finally, we demonstrate that the presence of stochastic volatility increases

the expected losses from using the simple strategy in Andersen (2000).

Keywords: Bermudan Swaptions; Control Variates; Exercise Strategy; Primal-Dual Algorithm; Stochastic Volatility (search for similar items in EconPapers)
Date: Written 2002-05-09
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