Smiling at Convexity: Bridging Swaption Skews and Cms Adjustments

16 Pages Posted: 21 Mar 2006

See all articles by Fabio Mercurio

Fabio Mercurio

Bloomberg L.P.

Andrea Pallavicini

Banca IMI; Imperial College London - Department of Mathematics

Date Written: May 25, 2006

Abstract

The price of a CMS based derivative is largely affected by the value of swaption volatilities at extreme strikes. In this article, we propose a very simple procedure for stripping consistently implied volatilities and CMS adjustments from the market quotes of swaption smiles and CMS swap spreads.

Keywords: swaption, CMS, volatility smile, volatility skew, convexity adjustment, SABR, stochastic volatility, calibration

JEL Classification: C61, G12, G13

Suggested Citation

Mercurio, Fabio and Pallavicini, Andrea, Smiling at Convexity: Bridging Swaption Skews and Cms Adjustments (May 25, 2006). Available at SSRN: https://ssrn.com/abstract=892287 or http://dx.doi.org/10.2139/ssrn.892287

Fabio Mercurio

Bloomberg L.P. ( email )

731 Lexington Avenue
New York, NY 10022
United States

Andrea Pallavicini (Contact Author)

Banca IMI ( email )

Largo Mattioli 3
Milan, MI 20121
Italy
+39 02 7261 (Phone)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
London SW7 2AZ, SW7 2AZ
United Kingdom

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