Swaption Pricing Using the SABR Model

Specialeforsvar: Nanna Ingemann Ohrt

Titel: Swaption Pricing Using the SABR Model

Abstract: This thesis investigates swaption pricing using the SABR (Stochastic Alpha, Beta, Rho) model, combined with a motivation for swaptions as a missing link i asset allocation.
Then the thesis examines the necessity for a two-factor model, to handle stochastic volatility. The SABR model is chosen to model the implied volatility and for pricing swaptions. This choice is made based on the investigation of the Vasicek model and a discussion of constant volatility.
Furthermore the thesis concludes on the parameter investigation and the risks related to the SABR model. The investigation reveals that swaption prices are, among other things, sensitive to changes in the short rate, as well as changes in the volatility of the short rate. These risks should be taken into account, if swaptions should be included when allocating assets. Finally the thesis suggest that swaptions fill a critical gap in asset allocation by providing positive performance in market conditions where traditional asset classes, such as equities and bonds, may under perform. This positions swaptions as a valuable addition to diversified portfolios.

Vejleder: Rolf Poulsen
Censor: Thomas Kokholm,  Aarhus Universitet