Inflation modelling with SABR dynamics

The inflation rates quoted in the interbank derivatives market are either zero-coupon (ZC) or year-on-year (YY), and underlie ZC and YY swaps, respectively. In a ZC swap, a fixed payment, based on the annual compounding of the quoted ZC rate, is exchanged at maturity for the inflation rate corresponding to the swap application period.1 In a YY swap, instead, payments are exchanged annually, with the floating payment that is based on the just-set annual inflation rate.

ZC and YY rates do not

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