I have been looking at Black implied volatility data for caps with the Euribor 6M underlying. With negative rates many of the shorter maturity caps have no listed volatilities, and this I completely understand, since the assumed (unshifted) geometric Brownian motion of the traditional Black model cannot go below zero.

However, in most cases tickers on Bloomberg do manage to list implied volatilities for longer maturity caps. Now my question is the following:

Since the prices of these caps, are a sum of caplet prices, I would expect that for all caplets that are exercised/fixed at dates at which our current forward curve is still negative, I cannot compute a price. Therefore I would expect that also for longer maturity caps there is no price computable because it depends on these negative rate caplets. How is this issue usually resolved?

Thanks in advance for any reply.

  • $\begingroup$ Are you sure that the quoted volatilities are, in fact, Black volatilities - and not normal vols? $\endgroup$ – AdB May 8 at 10:25
  • $\begingroup$ Yeah, definitely. $\endgroup$ – buzzie13 May 8 at 11:15

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