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UnRisk: Finance@Court
Andreas Binder

Municipalities would do well to analyze payoffs and the risk of swaps before taking a leap with taxpayers' money...

Low Strike Extrapolation for SABR - d-fine
Sebastian Schlenkrich, André Miemiec, Tilman Wolff-Siemssen, d-fine GmbH, Frankfurt, Germany

In this paper we analyse the modelling of rate options in a low interest rate market environment. In particular, the pricing of low, zero and negative strike vanilla options is considered. We review the modelling approaches available in the literature. For the important special case of the widely used SABR formula we illustrate the shortcomings connected with the low strike wing of the smile.

Moreover, a simple approach of low strike extrapolation will be presented. It is based on gluing the density function implied by the standard SABR formula to a suitable density function at low strikes in an arbitrage free manner. This approach yields a robust and transparent method to price low, zero and negative strike vanilla options.

Stochastic Processes in Finance - Part I: Wilmott Magazine Article
Jörg Kienitz 2414 Views

This is the first of a series of articles on stochastic processes in finance. This article covers the key concepts of the theory of stochastic processes used in finance. We work out a stochastic analogue of linear functions and discuss distributional as well as path properties of the corresponding processes.


[First published in issue 29 of Wilmott - May 2007]

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