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Pricing of Bermudan swaption: Valuing an exotic interest rate instrument using a numerical implementation of the Hull-White two-factor model
Umeå University, Faculty of Science and Technology, Department of Mathematics and Mathematical Statistics.
Umeå University, Faculty of Science and Technology, Department of Mathematics and Mathematical Statistics.
2017 (English)Independent thesis Advanced level (professional degree), 20 credits / 30 HE creditsStudent thesisAlternative title
Prissättning av Bermuda swaptioner : Värdering av ett exotiskt ränteinstrument med hjälp av en numerisk implementation av Hull-Whites två-faktor modell (Swedish)
Abstract [en]

Banks are involved in trades with sophisticated financial instruments. Hence, a need of methods in valuing these kinds of instruments is necessary. It can be challenging to perform these valuations, both due to the structure but also due to the dynamics of these instruments. This thesis will give an insight in how a Hull-White two-factor model can be implemented in a finite tree lattice and used to value exotic interest rate derivatives of type Bermudan swaption. This is a complex instrument to value due to its early exercise feature and the requirements of modelling the entire development of the term-structure. A numerical example visualizes the result provided by the model, followed up by a discussion to enhance the understanding of both the model and the result. In the numerical example provided in this thesis, the Hull-White two-factor model prices the Bermudan swaption slightly lower than the Hull-White one-factor model. A difference that is due to the extra flexibility the two-factor model provides with an extra stochastic movement. The result seems trustworthy since both models prices the Bermudan swaption with a premium compared to the Black-max value. The robustness test shows that three out of the five parameters are robust, while smaller movements in   and  cause a difference in the Bermudan swaptions value. The Hull-White two-factor model is more complex to calibrate compared to the Hull-White one-factor model, which leads to the question whether or not the cost of using a multifactor model is justified in relation to the marginal difference in pricing a Bermudan swaption. A question that the authors remain unanswered.

Place, publisher, year, edition, pages
2017. , 37 p.
Keyword [en]
Bermudan swaption, Hull-white, two-factor model, interest rate swap, trinomial trees
National Category
Mathematics
Identifiers
URN: urn:nbn:se:umu:diva-135875OAI: oai:DiVA.org:umu-135875DiVA: diva2:1106972
External cooperation
Handelsbanken Capital markets
Educational program
Master of Science in Engineering and Management
Supervisors
Examiners
Available from: 2017-06-13 Created: 2017-06-08 Last updated: 2017-06-13Bibliographically approved

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CiteExportLink to record
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Citation style
  • apa
  • harvard1
  • ieee
  • modern-language-association-8th-edition
  • vancouver
  • Other style
More styles
Language
  • de-DE
  • en-GB
  • en-US
  • fi-FI
  • nn-NO
  • nn-NB
  • sv-SE
  • Other locale
More languages
Output format
  • html
  • text
  • asciidoc
  • rtf