Convexity adjustments à la Malliavin

David García-Lorite and Raúl Merino

Journal of Computational Finance

Abstract: In this paper, we develop a new method based on the Malliavin calculus to approximate the convexity adjustment for various classical interest rate products. Malliavin calculus provides a simple way to get a template for the convexity adjustment. We find the approximation for futures, overnight index swap futures, forward rate agreements and constant maturity swaps within a general family of one-factor Cheyette models. In addition, we show the high accuracy of the numerical results obtained from the formulas.

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