Inflation Indexed Swaps and Swaptions

  • Date: 01/11/2007

Mia Hinnerich (Stockholm School of Economics)


University of British Columbia


This article considers the pricing of inflation indexed swaps,
inflation indexed swaptions, and options on inflation indexed bonds. To
price the inflation indexed swaps, we suggest an extended HJM model.
The model allows both the forward rates and the consumer price index to
be driven, not only by a standard multidimensional Wiener process but
also, by a general marked point process. Our model is an extension of
the HJM approach proposed by Jarrow and Yildirim (2003) and later also
used by Mercurio (2005) to price inflation indexed swaps. Furthermore
we price options on so called TIPS-bonds assuming the model is purely
Wiener driven. We then introduce an inflation swap market model to
price inflation indexed swaptions. All prices derived have explicit
closed form solutions. Furthermore, we formally prove the validity of
the so called foreign-currency analogy earlier used by Hughston (1998),
Jarrow & Yildirim (2003) and Mercurio (2005).

Other Information: 

MITACS Math Finance Seminar 2007