Hi all,I am thinking the difference between caps/floors and swaptions, especially in terms of how correlation will affect their values.I've done some survey about previous discussion of similar topics. However I still have few questions and wish someone could help to clarify.1. As correlation of forward rates decreases, will the value of swaption also decrease? how about caps/floors? Some people said that caps/floors will be more valuable if correlation of foraward rate decrease......2. It correlation of forward rate will affect value of caps/floors and swaption, in what way? I don't see any correlation shows in Black framework formula so I guess maybe correlation of forward rate will influence the forward swap rate and therefore affect the value of swaption....3.Theoretically the correlation of forward rate will determine the vlt spread between caps/floors and swaption, so in other words can we say the extent of mean-reverting will determine the vlt spread between caps/floors and swaption?Thanks for any comment and advice.

I think the best way for you to understand these issues is to think swap rate as a portfolio of fwd rates (weighted by daycounts and discount factors). So you can think of a swaption as a option on the portfolio of fwd rates, and capfloor as a portfolio of options on individual fwd rates. So if you think about it, you will see the swaption vol should be a function of the individual cap floors vols plus the covariance amonth the fwds. So a long/short swaptions vs capfloors will have considerable exposure to the fwd rate correlations. This should answer your questions below. But having said that, swaption vs capfloors is not the so called correlations trade (say for e.g. dispersion trades in equities, where you are long/short index options vs individual stock options). One reaosns - the weights are not constant, but more importantly the correls are not contemporaneous, it is in tiime, you have a net vega exposure and also curve steepness exposure, so in general, it might not be very useful to see these in terms of correlations. And while on the subject, a good reference you might want to look at is "relative valuation of caps and swaptions" by Lognstaff et al