Cutting Edge introduction: viva cross-vegas

The sensitivity of single-rate derivatives to implied volatility is traditionally only considered with respect to the underlying fixing, in effect collapsing the term structure to a point. But a full set of implied volatilities can be found using a new slant on replication. Laurie Carver introduces this month’s technical articles

Traditional models for pricing single-rate derivatives only look at their sensitivity to the implied volatility of the underlying rate – known as vega – in the same way that a single-stock equity option would typically be modelled. But fixed-income instruments are not like equities – no rate is an island, but instead exists within a term structure, subject to strict no-arbitrage requirements – and