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On Valuing Constant Maturity Swap Spread Derivatives
US Department of the Treasury, Washington DC, USA
- 1 US Department of the Treasury, Washington DC, USA
Journal of Mathematical Finance·Volume 02 (2012)·Pages 189–194·Published 23 May 2012·DOI10.4236/jmf.2012.22020
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Abstract
Motivated by statistical tests on historical data that confirm the normal distribution assumption on the spreads between major constant maturity swap (CMS) indexes, we propose an easy-to-implement two-factor model for valuing CMS spread link instruments, in which each forward CMS spread rate is modeled as a Gaussian process under its relevant measure, and is related to the lognormal martingale process of a corresponding maturity forward LIBOR rate through a Brownian motion. An illustrating example is provided. Closed-form solutions for CMS spread options are derived.
KeywordsCMS SpreadMarket ModelBrownian MotionForward Measure
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