Publication Type

Journal Article

Version

submittedVersion

Publication Date

8-2019

Abstract

We formulate a risk-based swaption portfolio management framework for profit-and-loss (P&L) explanation. We analyze the implication of using the right volatility backbone in the pricing model from a hedging perspective, and demonstrate the importance of incorporating stability and robustness measure as part of the calibration process for optimal model selection. We also derive a displaced-diffusion stochastic volatility (DDSV) model with a closed-form analytical expression to handle negative interest rates. Finally, we show that our framework is able to identify the optimal pricing model, which leads to superior P&L explanation and hedging performance.

Keywords

derivatives valuation, interest rate markets, swaptions, risk management, portfolio management, pricing and hedging, stochastic volatility models, SABR model

Discipline

Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance; Quantitative Finance

Publication

Journal of Derivatives

Volume

27

Issue

2

First Page

81

Last Page

107

ISSN

1074-1240

Identifier

10.3905/jod.2019.1.083

Publisher

Institutional Investor Inc.

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.3905/jod.2019.1.083

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