Can someone please suggest a practical framework for pricing Dual Binary IR Options with payoff like:If (USSWAP2Y >= x AND (USSWAP10Y - USSWAP2Y) >= y)Then 1Else 0(european style)Regular market data like Swap Curve; Swaption and Cap/Floor vol surface is available Thanks in advance.

QuoteOriginally posted by: manmeetCan someone please suggest a practical framework for pricing Dual Binary IR Options with payoff like:If (USSWAP2Y >= x AND (USSWAP10Y - USSWAP2Y) >= y)Then 1Else 0(european style)Regular market data like Swap Curve; Swaption and Cap/Floor vol surface is available Thanks in advance.1. Calibrate an interest rate model2. Use the model to generate 10,000 interest rate paths3. Evaluate the payoff under those paths (in this case you only need to look at the terminal distribution, which makes things easier)4. The average payoff is your price

Understood, essentially use monte carlo. Any thoughts on which IR Model would be most appropriate for this type of instrument?Thanks.

QuoteOriginally posted by: manmeetUnderstood, essentially use monte carlo. Any thoughts on which IR Model would be most appropriate for this type of instrument?Thanks.I would use a copula method with 2D integration. Using a term structure model seems like an overkill and will make calibration difficult. see (soon forthcoming) details here

Agree with Piterbarg. However, one also has to take into account things like convexity, skew/smiles and distributions. Swaption market would essentially give you everything about 2y swap rate distributions at every time point. For 10-2 spread, there is indicative broker market and totem survey, which might give you some ideas about 10-2 distributions. What's the relationship between the two? That's something you have to think about. Or from 10s distribution and 2s distributions, plus assumption between the two, you could derive the 10-2 distributions so that it matches 10-2 broker market. You would have to do numerical integration here.Piterbarg,Any comment? What's your thought on which model to take? Maybe you can share a little thought before your book is published. Do you discuss the cms spread option market in your book?