We propose an efficient approximation of the swaption normal volatility to estimate the mean reversion separately from the other volatility parameters in the Gaussian two-factor model. We compare our two-step approach with a one-step method that calibrates all parameters simultaneously. The comparison is based on the data from interest rate market of Korea and the US. The parameter estimates of our proposed two-step method are more stable than those of the one-step method in that the latter is overly sensitive to market changes whereas the former is not. The proposed approach also eliminates many existing problems in the Gaussian two-factor model.
Copyright: © 2023 Choi, Kang. This is an open access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.