Can someone explain, in layman's terms, the mechanics behind Bermudan Swapttions ( without having recourse to pricing models )?

Why are they popular? when are they used ?

How are they hedged i.e exercise strategy, main risk factors ( forward rates correlation, volatility ...etc.) ?

Any intuition / rule of thumb / approximation of pricing (e.g. wrt to its European swaption equivalent , weighted sum of European swaptions )

Now, and that is my main question, consider a strategy with a long bermudan swaption payer combined with a short European swaption payer ( with the same parameters ) i.e this captures only the optionality-feature. Any intuition about the price ? What would be the main risk in this case ? How to hedge it? Any approximation ?

  • $\begingroup$ You should think about the equity case, in BS where in no dividends case the both options are equal, and try to workout what happening in the dividend case. $\endgroup$
    – Olorin
    May 19 '18 at 16:41

See Blyth "An Introduction to Quantitative Finance" which has a whole chapter on the elementary properties of Bermudian swaptions and answers pretty much all of your questions.


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