Pricing Interest Rate Derivatives in a Multifactor HJM Model with Time

Ingo Beyna, Carl Chiarella and Boda Kang
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Ingo Beyna: Centre for Practical Quantitative Finance, Frankfurt School of Finance and Management

No 317, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: We investigate the partial differential equation (PDE) for pricing interest derivatives in the multi-factor Cheyette Model, which involves time-dependent volatility functions with a special structure. The high dimensional parabolic PDE that results is solved numerically via a modified sparse grid approach, that turns out to be accurate and efficient. In addition we study the corresponding Monte Carlo simulation, which is fast since the distribution of the state variables can be calculated explicitly. The results obtained from both methodologies are compared to the known analytical solutions for bonds and caplets. When there is no analytical solution, both European and Bermudan swaptions have been evaluated using the sparse grid PDE approach that is shown to outperform the Monte Carlo simulation.

Keywords: Cheyette model; Gaussian HJM; multi-factor model; PDE valuation; sparse grid; Monte Carlo simulation (search for similar items in EconPapers)
Pages: 65 pages
Date: 2012-10-01
New Economics Papers: this item is included in nep-cmp
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Citations: View citations in EconPapers (2)

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