How to calibrate Gaussian two-factor model using swaption

Myeongsu Choi and Hyoung-Goo Kang

PLOS ONE, 2023, vol. 18, issue 2, 1-21

Abstract: We propose an efficient approximation of the swaption normal volatility to estimate the mean reversion separately from the other volatility parameters in the Gaussian two-factor model. We compare our two-step approach with a one-step method that calibrates all parameters simultaneously. The comparison is based on the data from interest rate market of Korea and the US. The parameter estimates of our proposed two-step method are more stable than those of the one-step method in that the latter is overly sensitive to market changes whereas the former is not. The proposed approach also eliminates many existing problems in the Gaussian two-factor model.

Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:plo:pone00:0280829

DOI: 10.1371/journal.pone.0280829

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