Valuation of ATM European swaptions with the libor market model

Abstract

This working project developped a pricing tool for at-the-money European swaptions using the LMM. The tool is benchmarked by transforming quoted implied volatiliy of swaptions to market prices in euro, using Black’s formula. When including a volatility structure calibrated on market data, the tool succeeds in pricing swaptions with a 2 till 5 years tenor. For shorter tenors, 1 year, or longer tenors, 7-10 years, the tool does not perform well, due to issues fitting today’s unique volatility term structure. Improvements on the volatility calibration are suggested, as well as possible extensions of the tool towards non-at-the-money and exotic products.