Pricing swaptions and coupon bond options in affine term structure models

David F. Schrager*, Antoon A. J. Pelsser

*Corresponding author for this work

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We propose an approach to find an approximate price of a swaption in affine term structure models. Our approach is based on the derivation of approximate swap rate dynamics in which the volatility of the forward swap rate is itself an affine function of the factors. Hence, we remain in the affine framework and well-known results on transforms and transform inversion can be used to obtain swaption prices in similar fashion to zero bond options (i.e., caplets). The method can easily be generalized to price options on coupon bonds. Computational times compare favorably with other approximation methods. Numerical results on the quality of the approximation are excellent. Our results show that in affine models, analogously to the LIBOR market model, LIBOR and swap rates are driven by approximately the same type of (in this case affine) dynamics.
Original languageEnglish
Pages (from-to)673-694
Number of pages22
JournalMathematical Finance
Issue number4
Publication statusPublished - Oct 2006
Externally publishedYes


  • swaption
  • coupon bond option
  • affine term structure models
  • change of numeraire
  • swap measure
  • conditional characteristic function
  • option pricing using transform inversion

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