SABR Question: Why does the market take the beta parameter as a constant?
SABR Question: Why does the market take the beta parameter as a constant?
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Mike · External communityPost link
External question — Quantitative Finance Stack Exchange
Author: Mike
Original post: https://quant.stackexchange.com/questions/44273
License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/
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SABR Question
Why does the market take the
$\beta$
parameter as a "constant"?
I see most brokers quoting SABR parameters nowadays.
I've seen many banks use
$\beta$
=0.5 as a rule.
I've seen quants select a
$\beta$
based on best fit to calibration instruments.
What is most correct to the spirit of the paper, and explain any issues to anticipate with IMR/IPV processes.
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AKdemy · External communityPost link
External answer — Quantitative Finance Stack Exchange
Author: AKdemy
Original post: https://quant.stackexchange.com/a/63749
License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/
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Managing Smile risk
from Hagan et. al.
Generally if you pre-select
$\beta$
, it is from a priori considerations.
$\beta = 1$
corresponds to stochastic lognormal
$\beta = 0$
is stochastic normal
$\beta=1/2$
CIR
In the SABR model, beta is usually calibrated first, followed by the other 3 parameters. Frequently, instead of calibrating beta, it is simply assumed to have
$\beta=1/2$
(since CIR is widely used). That said, JPY it is also natural to select 0 for JPY due to negative rates.
The paper explains both. "Aesthetic" consideration (a priori - fixed) or determined form historical observations.
Click
here
for an intuitive explanation of the SABR model. How to estimate
$\beta$
can be seen in
this answer
.
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