MArkov-Functional with Smile

ddrdouble · October 24th, 2006, 7:21 am

Hi,if I wish to extend the plain markov functional model of hunt, pelsser and kennedy to a world with, is it just possible to change the input of the swaption volatilities and calculate the digital swaption values according to these volatilities given by the market? that means just calculate a cap spread with the smile data given by market input? kind regards

keztenpens · October 24th, 2006, 11:04 am

QuoteOriginally posted by: ddrdoubleHi,if I wish to extend the plain markov functional model of hunt, pelsser and kennedy to a world with, is it just possible to change the input of the swaption volatilities and calculate the digital swaption values according to these volatilities given by the market? that means just calculate a cap spread with the smile data given by market input? With Sabr formula you will obtain a smoother result

ddrdouble · October 24th, 2006, 11:59 am

I was thinking about that to, but I thought the problem of SABR formula is, that you get not a real density (maybe negative probabilities for high strikes)or am I wrong? and there are also problems for very low strikes, or not?

keztenpens · October 24th, 2006, 5:48 pm

QuoteOriginally posted by: ddrdoubleI was thinking about that to, but I thought the problem of SABR formula is, that you get not a real density (maybe negative probabilities for high strikes)or am I wrong? and there are also problems for very low strikes, or not?That's true. But it is possible to correct that with a "good" change of variable ...

ddrdouble · October 24th, 2006, 6:51 pm

a small hint?