CSA Caps Convexity Impact on Hull & White Calibration
CSA Caps Convexity Impact on Hull & White Calibration, Wilmott Magazine issue 75, Copyright © 2015, Wilmott.
16 Pages Posted: 10 Jul 2013 Last revised: 10 Apr 2015
Date Written: June 15, 2013
Prices of CSA instruments are observed in a world which is not natural for LIBOR based payoffs in the sense that LIBOR forward is not martingale under CSA-forward measure. From a theoretical perspective, pricing models for collateralized LIBOR based payoffs should account for CSA-convexity, implied when changing from CSA-forward measure to LIBOR-forward measure. In practice CSA-convexity effect is neglected. In the present paper we show how modeling jointly OIS and LIBOR using one factor guassian short rate dynamics allows to capture CSA-convexity on caps and we measure its impact on LIBOR volatility calibration in the Hull & White case.
Keywords: CSA convexity, Caps Pricing, Hull & White calibration, LIBOR Volatility, OIS Volatility, OIS LIBOR Correlation
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