For this episode of Quantcast, I speak with Patrick Hagan, the veteran quant who co-developed the ubiquitous SABR volatility model in 2002. He is now the managing director of Gorilla Science, a consultancy that develops quantitative models for pricing, hedging and managing risk in financial markets.
Hagan and Diana Woodward, a senior researcher at Gorilla Science, recently published an alternative solution to value convexity adjustments – a correction that accounted for the non-linear relationship between interest rates and prices in securities such as constant maturity swaps.
Their analytical formula overcomes the drawbacks of the replication method for valuing convexity adjustments, simplifying the hedging of vega risk for high strikes.
Hagan says the solution reduces the computational and operational burden associated with valuing convexity adjustments and has already been adopted by some…