Hi All,I am trying to calibrate swaption skew in SABR and struggling with choice of 2 approaches1. Using swpation strangles, risk reversals,straddles for calibration.2.retain skew from cap/floor and use same skew for swaptions using ATM Swaption vol as reference vol point on curve. ( which is suggested in Konikov's Bloomberg paper)- i think this is quite difficult and need vols of forward caplets.please guide me in terms of selection of accurate way of calibration.Regards,Qmartingle

I would go for the approach 1, that with a number of assumptions on your side can give you an intuitive way to manage your surface with relatively few instruments.I wouldn't go for the second approach because caps and swaption markets can drift a bit one from the other from time to time. Also apart from a few canonical caps&floors it's hard to know how tradable the forward-forward volatilty surface you can bootstrap from broker pages is (you can start comparing the screens of a few brokers and will see that for very OTM caps the quotes can be quite different).Also the way how you build the forward-forward vol surface for caps&floor from the flat vols for spot caps is quite subjective adding more uncertainty on how reliable the data from the two markets is.Maybe you could use the vols for the 1y caps to have a starting point for options on 3m/6m swap rates (in case you opt for the idea of Hagan to interpolate SABR parameters for the expiries where you don't have data). But I would be wary of any strict relationship between swaptions and cap&floors OTM vols.

Thanks gc.For Calibration purpose i will use swaption stangles,risk reversal quotes but how brokers intituively gauge changes in volatility of forward swap rate for OTM Strikes?I mean based on which logic broker quotes of vols for OTM swaption ( beyond 1y in option term ) changes?Regards,Qmartingle

Quotemean based on which logic broker quotes of vols for OTM swaption ( beyond 1y in option term ) changes?Well, hopefully brokers will see more of the market than most banks and above all their role is of market-making, so they can gauge volatility ranges because they can see where unmet bids and offers are for a number of OTM swaptions. At the end it depends a lot from how good a broker house is, because they will be able to make quotes based on:1. traded prices,2. (yet) unmatched bids/unmatched offers (they don't give you a volatility, but a lower or upper bounds)3. market dynamic that can put (2) in context.Then in most cases they would have their own internal model to fill-in the gaps and generated a possibly coherent surface.gc

Thanks gc, For point 2 and point 3Regards