On cash settled IRR-swaptions and Markov functional modeling
In this paper, we show how to consistently price cash settled Internal Rate of Return (IRR)-swaptions and derivatives on these contracts. There are several results worth highlighting. First, if we know at what fixed coupon an IRR-swap values to par, we can compute the price of any IRR-swaption in a way consistent with absence of arbitrage. We show that this fixed coupon, denoted the IRR-forward, c