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Comment: 6pages (LaTex)
In this work we describe the mathematical foundations used in the construction of primary fields of minimal models of conformal field theory. The work contains two parts: In the first part we give a description of Verma and Fock modules for the Virasoro algebra and develop their imbedding patterns. This part is a simplification of the work of Feigin and Fuks (we correct a mistake in their patterns in the case III_+), Rocha-Charidi and some new ideas which yield a simplification of the original papers. In the second part we define (free) vertex operators as unbounded Hilbert space operators, acting on Fock spaces, which are Virasoro modules. We prove several properties of these operators: under appropriate conditions vertex operators are densely defined, not closable operators. Radially ordered products of vertex operators exists on a d...
When pricing the convexity effect in irregular interest rate derivatives such as, e.g., Libor-in-arrears or CMS, one often ignores the volatility smile, which is quite pronounced in the interest rate options market. This note solves the problem of convexity by replicating the irregular interest flow or option with liquidly traded options with different strikes thereby taking into account the volatility smile. This idea is known among practitioners for pricing CMS caps. We approach the problem on a more general scale and apply the result to various examples.
interest rate options,volatility smile,convexity,,option replication
interest rate swap,cross currency swap,basis spread
We collect simple and pragmatic exact formulae for the convexity adjustment of irregular interest rate cash flows as Libor-in-arrears or payments of a swap rate (CMS rate) at an irregular date. The results are compared with the results of an approximative approach available in the popular literature. For options on Libor-in-arrears or CMS rates like caps or binaries we derive an additional new convexity adjustment for the volatility to be used in a standard Black & Scholes model. We study the quality of the adjustments comparing the results of the approximative Black & Scholes formula with the results of an exact valuation formula. Further we investigate options to exchange interest rates which are possibly set at different dates or admit different tenors. We collect general quanto adjustments formulae for variable interest rates to be...
Cross currency swaps are powerful instruments to transfer assets or liabilities from one currency into another. The market charges for this a liquidity premium, the cross currency basis spread, which should be taken into account by the valuation methodology. We describe and compare two valuation methods for cross currency swaps which are based upon using two different discounting curves. The first method is very popular in practice but inconsistent with single currency swap valuation methods. The second method is consistent for all swap valuations but leads to mark-to-market values for single currency off market swaps, which can be quite different to standard valuation results.
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