Interest Rate Model Calibration Using Semidefinite Programming
Computational Engineering, Finance, and Science
2007-05-23 v2
Abstract
We show that, for the purpose of pricing Swaptions, the Swap rate and the corresponding Forward rates can be considered lognormal under a single martingale measure. Swaptions can then be priced as options on a basket of lognormal assets and an approximation formula is derived for such options. This formula is centered around a Black-Scholes price with an appropriate volatility, plus a correction term that can be interpreted as the expected tracking error. The calibration problem can then be solved very efficiently using semidefinite programming.
Cite
@article{arxiv.cs/0302034,
title = {Interest Rate Model Calibration Using Semidefinite Programming},
author = {Alexandre d'Aspremont},
journal= {arXiv preprint arXiv:cs/0302034},
year = {2007}
}