On the American swaption in the linear-rational framework

Damir Filipovic and Yerkin Kitapbayev

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Abstract: We study American swaptions in the linear-rational (LR) term structure model introduced in [5]. 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 [7]. We characterize the optimal stopping boundary as the unique solution to a nonlinear 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.

Date: 2016-07, Revised 2018-02
New Economics Papers: this item is included in nep-ger
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