Risk managing bermudan swaptions in the libor BGM model
2003-08-07
Research Paper
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This article presents a novel approach for calculating swap vega per bucket in the Libor BGM model. We show that for some forms of the volatility an approach based on re-calibration may lead to a large uncertainty in estimated swap vega, as the instantaneous volatility structure may be distorted by re-calibration. This does not happen in the case of constant swap rate volatility. We then derive an alternative approach, not based on re-calibration, by comparison with the swap market model. The strength of the method is that it accurately estimates vegas for any volatility function and at a low number of simulation paths. The key to the method is that the perturbation in the Libor volatility is distributed in a clear, stable and well understood fashion, whereas in the re-calibration method the change in volatility is hidden and potentially unstable.
- volatility
- 0.0
- swap vega
- model
- swaption
- swap market model
- method
- swap rate
- perturbation
- libor
- market
- bucket
- stock
- bermudan
- swap rate volatility
- simulation
- libor bgm model
- price
- approach
- re-calibration
