QFRC Occasional Lecture:Calibrating the Volatility Skew (Part 1)
Calibrating the Volatility Skew (Part 1)
Presenter: Dr Alan Brace
National Australia Bank
Aim of these two lectures is to "decode" for practical implementation the method described in the Andersen and Piterbarg book on Interest Rate Modelling for calibrating an interest rate term structure model to the volatility skew. In their book, they describe techniques involving stochastic volatility models that can calibrate to both volatility skew and smile. We will concentrate on the shifted Libor Market Model (SLMM) because it is a relatively straightforward and stable model that fits much of the volatility skew, while illustrating many of the approximation and time averaging techniques involved.