Author(s)

Leonard Tchuindjo

US Department of the Treasury, Washington DC, USA.

Motivated by statistical tests on historical data that confirm the normal distribution assumption on the spreads between major constant maturity swap (CMS) indexes, we propose an easy-to-implement two-factor model for valuing CMS spread link instruments, in which each forward CMS spread rate is modeled as a Gaussian process under its relevant measure, and is related to the lognormal martingale process of a corresponding maturity forward LIBOR rate through a Brownian motion. An illustrating example is provided. Closed-form solutions for CMS spread options are derived.

CMS Spread; Market Model; Brownian Motion; Forward Measure

L. Tchuindjo, "On Valuing Constant Maturity Swap Spread Derivatives," Journal of Mathematical Finance, Vol. 2 No. 2, 2012, pp. 189-194. doi: 10.4236/jmf.2012.22020.