WIAS Preprint No. 1386, (2008)

Pricing CMS spreads in the Libor market model


  • Belomestny, Denis
  • Kolodko, Anastasia
  • Schoenmakers, John G. M.

2010 Mathematics Subject Classification

  • 60G44 91B28


  • CMS spread option, Margrabe's formula, Libor market model


We present two approximation methods for pricing of CMS spread options in Libor market models. Both approaches are based on approximating the underlying swap rates with lognormal processes under suitable measures. The first method is derived straightforwardly from the Libor market model. The second one uses a convexity adjustment technique under a linear swap model assumption. A numerical study demonstrates that both methods provide satisfactory approximations of spread option prices and can be used for calibration of a Libor market model to the CMS spread option market.

Appeared in

  • Int. J. Theor. Appl. Finance, 13 (2010) pp. 45--62.

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