EconPapers    
Economics at your fingertips  
 

On the Suboptimality of Single-Factor Exercise Strategies for Bermudan Swaptions

Mikkel Svenstrup ()
Additional contact information
Mikkel Svenstrup: Department of Finance, Aarhus School of Business, Postal: Fuglesangs Allé 4, 8210 Aarhus V, Denmark, http://www.asb.dk/EOK/FIN/STAFF/MSV_FORM.HTM

No 02-24, Finance Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies

Abstract: In this paper we examine the cost of using recalibrated single-factor

models to determine the exercise strategy for Bermudan swaptions in a

multi-factor world. We demonstrate that single-factor exercise strategies

applied in a multi-factor world only give rise to economically insignificant

losses. Furthermore, we find that the conditional model risk as defined

in Longstaff, Santa-Clara & Schwartz (2001), is statistically insignificant

given the number of observations. Additional tests using the Primal-Dual

algorithm of Andersen & Broadie (2001) indicate that losses found in

Longstaff et al. (2001) cannot as claimed be ascribed to the number of

factors. Finally we find that for valuation of Bermudan swaptions with

long exercise periods, the simple approach proposed in Andersen (2000)

is outperformed by the Least Square Monte Carlo method of Longstaff &

Schwartz (2001) and, surprisingly, also by the exercise strategies from the

single-factor models.

Keywords: Bermudan swaption; American option; Least Square Monte Carlo; Libor Market Model; Model Risk; Model Calibration (search for similar items in EconPapers)
Pages: 38 pages
Date: 2003-05-09
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.hha.dk/~MSV/facdep.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hhb:aarfin:2002_024

Access Statistics for this paper

More papers in Finance Working Papers from University of Aarhus, Aarhus School of Business, Department of Business Studies The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark. Contact information at EDIRC.
Bibliographic data for series maintained by Helle Vinbaek Stenholt ( this e-mail address is bad, please contact ).

 
Page updated 2025-03-30
Handle: RePEc:hhb:aarfin:2002_024