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I will try to use SABR Model to price call options in FX market. What does it mean to calibrate the model? As far as my understanding of the Wikipedia article goes, it means to estimate the parameters. In this case: Alpha, Beta and the correlation of the wiener process. Have I understood correctly?

If yes, Can I estimate the parameters from price history or does it have to option prices?

Thanks! Sanjay, India

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  • $\begingroup$ Calibration is finding the set of parameters for the function that replicate the observable. In this case, the SABR parameters which replicate the market values of the instruments you're calibrating to. Taking them from historical data is not calibrating - it will give you a good place to start your calibration though, hopefully make it faster. $\endgroup$
    – will
    Jul 14, 2016 at 14:29

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Indeed parameters are selected so that the quoted option prices are as close as possible to the model option prices. Alternatively, quoted and model implied volatilities can be used instead of prices.The first category are those that minimize the error between quoted and model. The second category,are those that minimize the error between quoted and model implied volatilities.

You can use these

  1. http://www.mathworks.com
  2. SABR Implied Volatility and Option Prices
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  • $\begingroup$ Thanks for your answer. How can I estimate the parameters from price history? Or does it have to option prices? $\endgroup$
    – user22571
    Jul 15, 2016 at 14:34
  • $\begingroup$ Please check two links $\endgroup$
    – user16651
    Jul 15, 2016 at 15:20

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