Pricing Asian-Style Interest Rate Swaps

Abstract

Derivatives with “Asian”-style payoffs are increasingly common, but often challenging to value. An Asian-style swap involves the exchange of interest computed at the average value of a floating rate over the period between settlement dates against a fixed swap rate. In this article, Chang and Chung derive a closed-form valuation equation for Asian swaps under the extended Vasicek interest rate model. In comparing Asian against European swap values, they show that the shape of the initial term structure makes a big difference.