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Fast drift approximated pricing in the BGM model

By Raoul Pietersz, Antoon Pelsser and Marcel Van Regenmortel

Abstract

This paper presents a method for fast drift approximated pricing in the BGM model (Brace, G¸atarek and Musiela, 1997). It is a significant addition to the predictor-corrector drift approximation method introduced by Hunter, Jäckel and Joshi (HJJ, 2001). HJJ use the drift approximation only to speed up their Monte Carlo by reducing it to single time-step simulation. We show that much more efficient numerical methods (e.g. finite differences) may be used at the cost of a minor additional assumption, separability. We also present a new drift approximation and propose a method to measure the accuracy of a drift approximation. This measure shows that our drift approximation is more accurate than the one of HJJ. We compare fast drift approximated pricing with Monte Carlo simulation for a Bermudan swaption, reporting a computational speed increase of a factor 10

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Year: 2004
OAI identifier: oai:CiteSeerX.psu:10.1.1.194.3731
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