Pricing a Bermudan Swaption with a Short Rate Lattice Method

Abstract

This paper presents the tree construction approach to pricing a Bermudan swaption. The Bermudan swaption is an option, which at each date in a schedule of exercise dates gives the holder the right to enter an interest swap, provided that this right has not been exercised at any previous time in the schedule. Assuming a common diffusion short rate dynamics, the Hull-White model, we propose a dynamic programming approach for their risk neutral evaluation. This framework is suited to a calibration from an observed initial yield curve and market price data of discount bonds and European swaptions.Bermudan swaption, swap rate, risk neutral evaluation, dynamic programming, Hull-White model, calibration.