Empirical analysis of interest rate swaptions

Abstract

The pricing formulas for coupon bond options derived in Chapter 11 are employed for an empirical study. This chapter studies the realization of swaptions as a special case of coupon bond options. Similar to the analysis of interest rate caplets in Chapter 10, by considering swaptions as a special case of coupon bonds, one in effect is using bond forward interest rates to model the swaptions. An empirical study of the swaption market is carried out in some detail and an efficient computational procedure is developed for analyzing swaption data. Empirical results of the swaption price, swaption volatility, and swaption correlation are compared with the predictions of the quantum finance model that generates, up to a scaling factor, the market swaption prices to an accuracy of over 90%. Introduction Interest rate swaptions have a deep and liquid market and arguably are today the most liquid option on interest rates; one of their major components is the highly liquid European swaptions. Swaption pricing is a nonlinear problem that has been widely studied using numerical techniques.