Watanabe's expansion: A Solution for the convexity conundrum
Watanabe’s expansion: A Solution for the convexity conundrum ArXiv ID: 2404.01522 “View on arXiv” Authors: Unknown Abstract In this paper, we present a new method for pricing CMS derivatives. We use Mallaivin’s calculus to establish a model-free connection between the price of a CMS derivative and a quadratic payoff. Then, we apply Watanabe’s expansions to quadratic payoffs case under local and stochastic local volatility. Our approximations are generic. To evaluate their accuracy, we will compare the approximations numerically under the normal SABR model against the market standards: Hagan’s approximation, and a Monte Carlo simulation. ...