Pricing Switch-Option-Embedded Notes In A LIBOR Market Model

Many interest rates models are deduced to price the interest rates derivatives and products. In China, most interest rate derivatives are embedded into the other products and most of them couldn't be priced in the close-form solution under the complex structure. The LIBOR market model which is applied broadly in practice for its completeness system and more closeness to the reality is used in pricing the path-dependent derivative products and will be introduced in details in the thesis.This thesis also introduces the pricing process of the switch-option-embedded notes issued by China Development Bank in the LIBOR market model. Actually, there are three notes, one of which is linked to the fixed rate and two of which are linked to the floating rates, 1-year deposit rate and the 3-month SHIBOR rate. The investors have the option to switch into the other two notes at each reset date. The process to pricing the notes includes the initial establishment of the yield curve with the term structure of the swaps in the market, the calibration of the forward rates volatilities, the Monte Carlo simulation via LIBOR market model and simulation of the deposit rate path. The initial forward rates can be generated under the techniques of bootstrapping and cubic spline and the parameters can be calibrated under the swap data.The notes value is negative to the drift of the forward rates but positive to the drift of the volatility as the result of the sensitive analysis. The comparison between the theoretical values and the actual bidden value in the market illustrates the inefficiency of the market in China and the inadaptability of the LIBOR market model.