TITLE:
On Valuing Constant Maturity Swap Spread Derivatives
AUTHORS:
Leonard Tchuindjo
KEYWORDS:
CMS Spread; Market Model; Brownian Motion; Forward Measure
JOURNAL NAME:
Journal of Mathematical Finance,
Vol.2 No.2,
May
23,
2012
ABSTRACT: 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.