Cash-Settled Swaption Annuity in BlackSwaptionEngine

Posted by Paul Giltinan on
URL: http://quantlib.414.s1.nabble.com/Cash-Settled-Swaption-Annuity-in-BlackSwaptionEngine-tp15810.html

Hi,

I have a question about the pricing of cash-settled swaptions using QuantLib::BlackSwaptionEngine.

The BlackSwaptionEngine calculates the annuity term for cash-settled swaptions by constructing a temporary discount curve from the forward swap rate  (see row 118 of blackswaptionengine.cpp). However, this curve is then assigned the same reference date as the regular discount curve, which means that the discounting occurs all the way to the evaluation date.

According to Mercurio (http://www.fabiomercurio.it/cashsettled_note.pdf, equation (3)), this discounting should only be applied as far as the cash settlement date of the swaption. I therefore propose a fix which changes the reference date of the aforementioned swap-implied discount curve and thus implements the pricing formula suggested by Mercurio.

If there are no objections I can provide a patch to fix this (code segment below).

Kind regards,

Paul Giltinan

Current implementation

case Settlement::Cash: {

const Leg& fixedLeg = swap.fixedLeg();

boost::shared_ptr<FixedRateCoupon> firstCoupon =

boost::dynamic_pointer_cast<FixedRateCoupon>(fixedLeg[0]);

DayCounter dayCount = firstCoupon->dayCounter();

Real fixedLegCashBPS =

CashFlows::bps(fixedLeg,

InterestRate(atmForward, dayCount, Compounded, Annual),

false, discountCurve_->referenceDate()) ;

annuity = std::fabs(fixedLegCashBPS/basisPoint);

break;

} Proposed Change case Settlement::Cash: { const Leg& fixedLeg = swap->fixedLeg(); boost::shared_ptr<FixedRateCoupon> firstCoupon = boost::dynamic_pointer_cast<FixedRateCoupon>(fixedLeg[0]); DayCounter dayCount = firstCoupon->dayCounter(); Date swapStartDate = firstCoupon->accrualStartDate(); Real fixedLegCashBPS = CashFlows::bps(fixedLeg, InterestRate(atmForward, dayCount, Compounded, Annual), false, swapStartDate); annuity = discountCurve_->discount(swapStartDate) * std::fabs(fixedLegCashBPS/basisPoint); break; }

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