Options on normal underlyings with an application to the pricing of survivor swaptions

Survivor derivatives are gaining considerable attention in both the academic and practitioner communities. Early trading in such products has generally been confined to products with linear payoffs, both funded (bonds) and unfunded (swaps). History suggests that successful linear payoff derivatives are frequently followed by the development of option-based products. The random variable in the survivor swap pricing methodology developed by Dowd et al [2006] is (approximately) normally, rather than lognormally, distributed and thus a survivor swaption calls for an option pricing model in which the former distribution is incorporated. We derive such a model here, together with the Greeks and present a discussion of its application to the pricing of survivor swaptions. © 2009 Wiley Periodicals, Inc.