Research

Pricing Bermudan Swaptions

This paper studies the practical pricing of Bermudan swap options, attempting to find both lower and upper bounds for the option price. It uses the BGM model with three driving factors and Monte Carlo simulation for determining the evolution of forward interest rates. A discretisation proposed by Glasserman is used, as an alternative to direct discretisation of the forward rates. Two suboptimal exercise strategies using exercise boundaries proposed by Andersen are evaluated for finding the lower bound for the option price. A perfect foresight strategy is evaluated for finding an upper bound. This paper also studies the systematic errors in the forward rate evolution and discusses simple measures for reducing their impact on the option pricing.