Risk managing bermudan swaptions in the libor BGM model

Raoul Pietersz () and Antoon Pelsser

No EI 2003-33, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

Abstract: This article presents a novel approach for calculating swap vega per bucket in the Libor BGM model. We show that for some forms of the volatility an approach based on re-calibration may lead to a large uncertainty in estimated swap vega, as the instantaneous volatility structure may be distorted by re-calibration. This does not happen in the case of constant swap rate volatility. We then derive an alternative approach, not based on re-calibration, by comparison with the swap market model. The strength of the method is that it accurately estimates vegas for any volatility function and at a low number of simulation paths. The key to the method is that the perturbation in the Libor volatility is distributed in a clear, stable and well understood fashion, whereas in the re-calibration method the change in volatility is hidden and potentially unstable.

Keywords: bermudan swaptions; central interest rate model; libor BGM model; risk management; swap market model (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2003-08-07
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Citations: View citations in EconPapers (1)

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