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I'm using VCUB on Bloomberg for ATM cap volatilities and have noticed there are a few "flavors" of volatilities. I would like simply use ATM flat vols to bootstrap forward volatilities from caplets using Black's formula.

In this case, I am assuming that Black Vol (IBOR) would be the correct choice for obtaining data on flat implied volatilities from the cap prices (from which fwd vols can be found).

Would anyone know if this is the right way to go? If not, is one volatility favored over another (ex: Black (OIS) vs. Black (IBOR))?

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  • $\begingroup$ If you want to use the Black model/formula to convert between price and vol, you should use Black-style quotes. Can you expand on what Black (OIS) and Black (IBOR) mean? I'd assume it boils down to discounting style? $\endgroup$
    – KevinT
    Commented Mar 31, 2021 at 6:18

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This depends on the currency you're looking at really. If you are pricing a cap/floor on for example EUR or CHF, then using Black is not particularly useful. The reason is because you have both negative strikes (e.g. -50bp floor) and negative rates which results in a big hole in the volatility surface. You will notice that up to ~10 years time to expiry that you will not be able to generate any vols using Black76.

The solution to this problem would be using the Normal/Bachelier model. There are many posts available such as this one. Most market makers will quote caps/floors in normal bp vol (or forward premia) terms. For some EM currencies you will see that the convention is quoting in Black terms however (perhaps ZAR or KRW?).

In terms of discounting the market standard is to use OIS discounting and hence Normal(OIS) is most popular. Remember that the swap curves (e.g. 6m€L) are OIS (that is €STR) stripped anyways.

Once you have generated your surface with Normal(OIS) you can still convert back to Normal(IBOR) or Black, if possible.

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