Cash-settled European Swaptions

By | 27 January 2017

The standard market formula used to price cash-settled swaptions is a copy of the physical delivery Black formula, where the classical annuity term is replaced with a single-factor one (discounting on the underlying swap rate fixing at maturity).

As reported in Mercurio and OpenGamma notes, this formula is not arbitrage-free. In order to get a proper pricing, one has to take into account the convexity between the swap rate and the ratio cash settled vs. physical annuity.

Cash-settled European Swaptions

 

Category: Modelling

About Franck Albert

X-Pont (1994 promotion), Franck Albert is a former exotic options trader for HSBC in Paris and BNP Paribas in London. From January 2009 to April 2016, he has been head of the quantitative fixed income risk team at BNP Paribas London, before joining CRZ Pricing as co-founder.

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