Valuing Interest Rate Swap Contracts in Uncertain Financial Market

Xiao, Chen; Zhang, Yi; Fu, Zongfei

doi:10.3390/su8111186

Volume 8, Issue 11

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Sustainability 2016, 8(11), 1186; https://doi.org/10.3390/su8111186

Valuing Interest Rate Swap Contracts in Uncertain Financial Market

Chen Xiao^1,†, Yi Zhang^2,* and Zongfei Fu²

Department of Electrical and Computer Engineering, Stevens Institute of Technology, Hoboken, NJ 07030, USA

School of Information, Renmin University, Beijing 100872, China

Author to whom correspondence should be addressed.

^†

Current address: School of Finance, Nankai University, Tianjin 300071, China.

Academic Editors: Xiang Li, Jian Zhou, Hua Ke, Xiangfeng Yang and Giuseppe Ioppolo

Received: 12 September 2016 / Revised: 25 October 2016 / Accepted: 3 November 2016 / Published: 18 November 2016

(This article belongs to the Special Issue Sustainability of Economic and Management Systems: Perspectives of Uncertainty and Data Driven Optimization)

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Abstract

Swap is a financial contract between two counterparties who agree to exchange one cash flow stream for another, according to some predetermined rules. When the cash flows are fixed rate interest and floating rate interest, the swap is called an interest rate swap. This paper investigates two valuation models of the interest rate swap contracts in the uncertain financial market. The new models are based on belief degrees, and require relatively less historical data compared to the traditional probability models. The first valuation model is designed for a mean-reversion term structure, while the second is designed for a term structure with hump effect. Explicit solutions are developed by using the Yao–Chen formula. Moreover, a numerical method is designed to calculate the value of the interest rate swap alternatively. Finally, two examples are given to show their applications and comparisons. View Full-Text

Keywords: interest rate swap; uncertain process; uncertain differential equation; Yao-Chen formula

This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited (CC BY 4.0).