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.

bermudan swaptions, central interest rate model, libor BGM model, risk management, swap market model
Contingent Pricing; Futures Pricing (jel G13)
hdl.handle.net/1765/904
Econometric Institute Research Papers
Erasmus School of Economics

Pietersz, R, & Pelsser, A.A.J. (2003). Risk managing bermudan swaptions in the libor BGM model (No. EI 2003-33). Econometric Institute Research Papers. Retrieved from http://hdl.handle.net/1765/904