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Quick takeaways
- Transition from LIBOR to compounded rates affects swaptions with non-vanilla payoffs and exotic transformations.
- Discrepancy in pricing between physical delivery and cash-settled options due to differences in underlying rates and convexity adjustments.
Deep dives
Challenges in Transition: Vanilla Swaptions Become Exotic
The transition from LIBOR to overnight compounded rates with spreads has complex implications for swaptions due to different conventions and frequencies. The replacement process involves curve calibration and interpolation, resulting in non-vanilla aspects like square roots in option payoffs, leading to exotic transformations.
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