Transforming Volatility - Multi Curve Cap and Swaption Volatilities
22 Pages Posted: 22 Jan 2013 Last revised: 27 Mar 2013
Date Written: March 22, 2013
In this document we consider the problem of deriving volatilities of non-standard tenors given quotes for standard tenors. Especially, we aim to derive volatilities for caps and swaptions from given quotes for a short tenor, for instance 3m, and derive volatilties for a longer tenor, for instance 6m. Furthermore, we also consider the other way of transforming long tenor volatilities to short tenor ones. We first consider the single curve framework and then transferring the results to a multi curve framework which is the standard market approach after 2007. We apply a displaced diffusion approach for the volatility transformation. Finally, we give several examples and outline the transfer algorithm.
Keywords: Cap, Swaption, Displaced Diffusion, Volatility, Multi Curve, Money Market Basis
JEL Classification: C13, C63
Suggested Citation: Suggested Citation