Why using "Basis Point Volatility" is better than "Relative Rate Volatility"?

Quote from tray_dar:

Hi Martin, what if your pnl is calculated using lognormal % movement?

I'm thinking more from a strategy angle, say a swaption RV trade looks very good on a chart on a normalised basis but not so good in lognormal. How can you cater for this?
More...
Well, to be honest, I have never seen anyone in the rates world calculating PNL in %age terms (but then again, I have never traded yen; still, I believe that even in yen, it's all about the basis points).

As a result, I have never seen anyone look at lognormal vol charts. However, given the brave new world of 0% rates across the globe, it is worthwhile.

So, I suppose, the answer to your question is that your assessment of a given trade would depend on your view of the current vol regime. If rates are low, you may conclude that the world is largely lognormal and pay more attention to Black prices/vols. Otherwise, the world is normal, in which case normal makes a lot more sense.
 
someone who knows what he is talking about, glad to see that!!!

To the others: If you express interest in learning about the pros and cons of each interest model then I recommend the paper by Marc Henrard "Swaptions: One price, ten deltas". Also Pat Hagan's paper on SABR is a good starting point!!!


Quote from Martinghoul:

OT, now you be talking loco...

If I were to guess, you got the two terms out of Burghardt's Eurodollar book. Point is that there's actually three types of vol people in the world of rates talk about: lognormal, normalized, aka bpvol (lognormal * forward), and normal. Now normalized vol is actually a rough approximation to proper normal vol, which is, generally, the most fundamental basic concept that modern practitioners in the world of rates still refer to.

to dmo: In practice, modern mkts conventions have gone beyond simple normal distributions wherever possible (e.g. vanilla rates products, such as Eurodollar options, swaptions, caps/floors etc). SABR (which is a very computationally tractable stoch vol model) and its various flavors is what's most commonly used nowadays. One exception is the bond futures mkt, where it's quite difficult to deal with the various options embedded in the actual underlying, so people would still, most commonly, rely on Black-Scholes.
More...
 
Believe me it does happen in dollar/euro/sterling and not just yen!

Say the market was normalised and I want to put on a normalised strategy - is it possible to workaround this for lognormal pnl? For e.g. what I don't gain in black vega i would make some of it on the delta etc....or does it simply not work.

Also, are complex equity vol strategies applicable to the rates world? I sense that only fairly basic strategies are used in swaptions e.g straddles, strangles, payer/receiver spreads etc but rarely multiple combinations as discussed on this forum....
 
Quote from OddTrader:

Why using "Basis Point Volatility" is better than "Relative Rate Volatility"?

Are they really useful? and

How to use them properly?
More...
Every bb has a pedantic pinhead poster who asks for info about obscure topics he searches for in books, white papers, etc.
 
Quote from tray_dar:

Believe me it does happen in dollar/euro/sterling and not just yen!

Say the market was normalised and I want to put on a normalised strategy - is it possible to workaround this for lognormal pnl? For e.g. what I don't gain in black vega i would make some of it on the delta etc....or does it simply not work.

Also, are complex equity vol strategies applicable to the rates world? I sense that only fairly basic strategies are used in swaptions e.g straddles, strangles, payer/receiver spreads etc but rarely multiple combinations as discussed on this forum....
More...
I don't know, dude... I only speak based on my own, personal, first-hand experience. In the world of rates, I have never seen anyone look at their pnl in %ages (maybe real money people do).

Yes, indeed, you can always work around the normal/lognormal issues in a reasonably simple manner (it just involves looking at converting the various partials; for a good treatment of this you can look at Marc Henrard's paper that asiaprop mentioned). Problem is that for any OTM options all these methods, even the more sophisticated ones, degrade quite badly. Then all your risk factor pnl attribution starts going screwy.

You're right that in the world of rates things normally don't get too exotic. Simple reason for this, in my view, is bid/offer. The wondrous multi-leg monsters you could do in equity options quickly start looking very ugly once you realize how far from mid you're likely to get anything done. Besides, I personally never understood the reason for doing these monster trades in equities/indices in the first place.

asiaprop: yes, indeed... The Henrard piece and the "Managing Smile Risk" by Pat Hagan are the seminal SABR papers. There's also a few more recent corrections to the model. You can see many threads on this on Wilmott or Nuclear Phynance.
 
yeah, I try to keep up with the changes to SABR (dynamic SABR, calibration issue) but I moved long time ago to the equity and fx space where SABR is rarely used. Just remembered the good ol times ;-)
Wilmott is a great forum for mostly rates geeks, they really know their stuff.

Quote from Martinghoul:

I don't know, dude... I only speak based on my own, personal, first-hand experience. In the world of rates, I have never seen anyone look at their pnl in %ages (maybe real money people do).

Yes, indeed, you can always work around the normal/lognormal issues in a reasonably simple manner (it just involves looking at converting the various partials; for a good treatment of this you can look at Marc Henrard's paper that asiaprop mentioned). Problem is that for any OTM options all these methods, even the more sophisticated ones, degrade quite badly. Then all your risk factor pnl attribution starts going screwy.

You're right that in the world of rates things normally don't get too exotic. Simple reason for this, in my view, is bid/offer. The wondrous multi-leg monsters you could do in equity options quickly start looking very ugly once you realize how far from mid you're likely to get anything done. Besides, I personally never understood the reason for doing these monster trades in equities/indices in the first place.

asiaprop: yes, indeed... The Henrard piece and the "Managing Smile Risk" by Pat Hagan are the seminal SABR papers. There's also a few more recent corrections to the model. You can see many threads on this on Wilmott or Nuclear Phynance.
More...
 
Quote from asiaprop:

yeah, I try to keep up with the changes to SABR (dynamic SABR, calibration issue) but I moved long time ago to the equity and fx space where SABR is rarely used. Just remembered the good ol times ;-)
Wilmott is a great forum for mostly rates geeks, they really know their stuff.
More...
Yep... As I understand it, SABR does get used occasionally in the equity world, but has its own unique set of issues there.
 
I have seen some guys using it at fx trading desks but it does not even seem to be used to price contracts such as standard one-touchs. I see it as being a lot more applicable to exotic fixed income and fx products, such as range accruals or PRDCs.

Anyway, back to trading (rather than pricing): Treasuries seem to be well bid after the FOMC announcement. Interesting to see whats gonna eventually happen when the slightest hint of inflation will linger around. My bet is the Fed will again be behind the curve on that one, but it may take many months/2-3 years till we see that. For now this steepness seems to invite healthy bids in the 10year.

On the equity front I play the short side for the first time in many weeks. Shorted S&P 1080 calls expiring Sep30 and Oct16.


Quote from Martinghoul:

Yep... As I understand it, SABR does get used occasionally in the equity world, but has its own unique set of issues there.
More...
 
Quote from asiaprop:

I have seen some guys using it at fx trading desks but it does not even seem to be used to price contracts such as standard one-touchs. I see it as being a lot more applicable to exotic fixed income and fx products, such as range accruals or PRDCs.

Anyway, back to trading (rather than pricing): Treasuries seem to be well bid after the FOMC announcement. Interesting to see whats gonna eventually happen when the slightest hint of inflation will linger around. My bet is the Fed will again be behind the curve on that one, but it may take many months/2-3 years till we see that. For now this steepness seems to invite healthy bids in the 10year.

On the equity front I play the short side for the first time in many weeks. Shorted S&P 1080 calls expiring Sep30 and Oct16.
More...
I don't know, dude...

I am very confused now, torn in all sorts of directions. FWIW, I'd still be long spooz here. I don't think the inventory rebuild story has yet run its course completely, so I think we'll be hearing more bullish stories yet. The only way I can explain the bid for nominal FI against this backdrop is simply that there's so much previously sidelined money that's being pumped into all and any assets.

At any rate, maybe this is the wrong forum for this discussion.
 
lol, true point (your last comment).

back to bpvol...;-)


Quote from Martinghoul:

I don't know, dude...

I am very confused now, torn in all sorts of directions. FWIW, I'd still be long spooz here. I don't think the inventory rebuild story has yet run its course completely, so I think we'll be hearing more bullish stories yet. The only way I can explain the bid for nominal FI against this backdrop is simply that there's so much previously sidelined money that's being pumped into all and any assets.

At any rate, maybe this is the wrong forum for this discussion.
More...
 
You must log in or register to reply here.
Back
Top