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You can consider the CPI index like a stock, and treat the floor like a put option. You can measure the historical volatility of this index by looking at the monthly data. In the case of the US, we are talking about the non seasonally adjusted CPI index CPURNSA. You should find historical volatility around 2pct per annum, and like many markets I think the ...


We can also think in a more discrete way. Lets take for example a put option with $5 strike. If the underlying asset has 50% chance of valuing 2 and 50% of valuing 4, the price of the asset would be 3 and the value of put would be (3*0,5 + 1*0,5) =2 Now, assume an increase in volatility and asset can value 1 or 5 with same probabilities... Asset price ...


Let's say K=1. If c=0.5, you get a shape like this (as you alluded to): And for c=-0.5, you get this shape: So does look like butterfly.

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