In this video blog, Dr. Alexandre Antonov, Senior Vice President of Quantitative Research at Numerix, discusses how the recent development of the Free Boundary SABR model for option pricing is a natural and efficient extension of the classical SABR model.
He explores how the Free Boundary SABR model is especially effective in the low and negative interest rate environments recently seen in Europe and Japan. Alexandre also highlights how the Free Boundary SABR Model is able to overcome some of the limitations presented by the Shifted SABR Model.
Video transcript: - See more at: http://blog.numerix.com/#sthash.JaX4rfTU.dpuf
Jim Jockle (Host): Hi welcome to Numerix Video Blog, your expert source for derivatives trends and topics. I’m your host Jim Jockle.
In the current interest rate environment, especially in Europe and Japan, we are seeing deposit rates below zero, and market rates in negative territory. As a result, financial institutions are finding themselves challenged on many fronts, in particular in terms of their option pricing models.
As this is becoming critically important, joining me today to discuss this is Alexandre Antonov, Senior Vice President of Quantitative Research at Numerix. Welcome Alexandre.
Alexandre Antonov (Guest): Thank you, Jim. Thank you for inviting me.
Jockle: Thank you. So question, when dealing with things like – negative strikes and forwards for short maturity caps and swaptions, how does this negative rate issue impact the volatility surfaces?
Antonov: Actually, the difference is twofold. The first thing is that we should change the quotation of the swaptions. The second thing, we should change the interpolation. So, the first issue is technically not that complicated, instead of making the quotation in terms of lognormal volatility, which we all get used to when the rates are positive. We should change option quotations for zero and negative strikes because they do not work for the lognormal (Black-Scholes) volatility.