Swaption portfolio risk management: Optimal model selection in different interest rate regimes

Swaption portfolio risk management: Optimal model selection in different interest rate regimes

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 mea...

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Bibliographic Details
Main Authors: NEO, Poh Ling, TEE, Chyng Wen
Format: text
Language:English
Published: Institutional Knowledge at Singapore Management University 2019
Subjects:
derivatives valuation
interest rate markets
swaptions
risk management
portfolio management
pricing and hedging
stochastic volatility models
SABR model
Finance and Financial Management
Portfolio and Security Analysis
Online Access:https://ink.library.smu.edu.sg/lkcsb_research/6404
https://ink.library.smu.edu.sg/context/lkcsb_research/article/7403/viewcontent/Swaption_Portfolio_Risk_Management_sv.pdf
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Institution: Singapore Management University
Language: English
Description
Summary: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.

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