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karfey
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Joined: October 3rd, 2012, 12:37 am

Capfloor vs swaption vol skew

October 26th, 2012, 5:39 pm

Hi,if my observations are correct, capfloor volatility are usually quoted with sticky strike and swaption volatility are usually quoted in moneyness.Can anyone explain if there is any business or theoretical reasoning for it?Secondly, how does the skew look for interest rate markets? Negative or positive? We know for equity markets the skew is almost always negative, to reflect the "market takes the staircase up and the escalator down" sentiments.Thanks.
 
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prodiptag
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Joined: September 12th, 2008, 4:41 pm

Capfloor vs swaption vol skew

October 28th, 2012, 4:34 am

I would not say that is what it is, you see relative strikes in CF markets as well. But usually client flows from CF is more with sticky strikes, than in swaptions. So yes there is a slight bias.The skew these days, especially for gamma part of the surface is pretty much positive (positive -> payer skew > receiver skew), and in some cases very positive (especially the upper left, i.e. short dated/ short tenor combination). More to do with low levels of rates. Elsewhere can be negative (like down right -> long dated/long tenors)
 
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karfey
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Posts: 58
Joined: October 3rd, 2012, 12:37 am

Capfloor vs swaption vol skew

November 6th, 2012, 12:36 pm

Thanks for your confirmation.Can we perhaps interpret a positive skew on rate volatility (higher strike, higher vol) as the fear of high rates dominating the fear of low rates on the market?Which means, bond holders on one hand, and bond sellers (or perhaps insurance companies who often guarantee a minimum rate of return) on the other.What is also interesting to note is that the skew on gold price vol is positive. Does that correlate to a flight to safety (into gold) in the event of a financial catastrophe?
Last edited by karfey on November 5th, 2012, 11:00 pm, edited 1 time in total.
 
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prodiptag
Posts: 124
Joined: September 12th, 2008, 4:41 pm

Capfloor vs swaption vol skew

November 7th, 2012, 5:30 am

Honestly, I wont pretend to understand why the skew is positive out there - techinically low rates and zero bounds means pdf should be skewed towards positive side. But would not go as far as fear/greed etc. Yes, even as late as early 2011 the market was divided and some believed in the story of inflation. But I doubt any majority now strongly hold this view. So apart from demand and supply, I do not think some fear/ greed like equity market is at play here. May be on the longer tenors (like 10y/30y tails), but at least not for the shorter tenors - which I would hazard a guess msotly driven by caps demands for hedgers lately. And also gamma side skew reprices to a significant extent on realzied correlation between amt vol and atm rates, which we have seen quite positive in recent times, and that would naturally lead to a positive skew - without any fear or greed factorsAnd thanks for the gold bit, I am not familiar with the vol market there, but it is interesting to note
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