In this article, we present the analytical approximation of zero-coupon bonds and swaption prices for general short rate models. The approximation is based on regular and singular expansions with respect to the small volatility and contains a low-dimensional integration. The model in hand assumes the short rate is an arbitrary function of a multi-dimensional Gaussian underlying process. The high approximation accuracy is confirmed by numerical experiments. 

We have treated two special classes of the model. The first one is a Generalized multi-factor Black-Karasinski (BK) model. The second one is a new Bounded short rate model where the rates evolve between certain user-defined limits. This model is particularly attractive for scenario generation and, due to the proposed swaption approximation, can be easily calibrated to the implied market.

Authors: Alexandre Antonov, PhD and Michael Spector, PhD

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Numerix Journal Vol. 8, No. 1


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