A Multi-Factor SABR Model for Forward Inflation Rates

19 Pages Posted: 5 Feb 2009 Last revised: 8 Apr 2010

Date Written: January 1, 2009

Abstract

We introduce a new forward CPI model that is based on a multi-factor volatility structure and leads to SABR-like dynamics for forward inflation rates. Our approach is the first in the financial literature to reconcile zero-coupon and year-on-year quotes, granting, at the same time, a both fast and accurate calibration to market data. Explicit formulas for year-on-year caps/floors as well as for zero-coupon options are then derived in terms of the SABR volatility form. An example of calibration to market data is finally provided.

Keywords: Inflation, SABR dynamics, closed-form formulas, calibration

JEL Classification: C21, C63, E31, G12

Suggested Citation

Mercurio, Fabio and Moreni, Nicola, A Multi-Factor SABR Model for Forward Inflation Rates (January 1, 2009). Bloomberg Portfolio Research Paper No. 2009-08-FRONTIERS. Available at SSRN: https://ssrn.com/abstract=1337811 or http://dx.doi.org/10.2139/ssrn.1337811

Fabio Mercurio (Contact Author)

Bloomberg L.P. ( email )

731 Lexington Avenue
New York, NY 10022
United States

Nicola Moreni

Banca IMI ( email )

Largo Raffaele Mattioli 3
Milano, 20121
Italy

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