Re: Why inflation zero floor prices to zero

Posted by Chris Kenyon-2 on
URL: http://quantlib.414.s1.nabble.com/Re-Why-inflation-zero-floor-prices-to-zero-tp7570.html

Hi Ivan,

your observations are exactly correct:
1) in a Black world a zero floor has no value because you can't get there.  A YoYInflationBlackCapFloorEngine implements this so, yes, you always get zero NPV.
2) If you use a displaced diffusion then, yes, you can see value in a zero floor.  This is implemented in the UnitDisplacedBlackYoYInflationCouponPricer for coupons and there is an analogous engine for instruments.
3) Alternatively you can use a Normal process and use the BachelierYoYInflationCouponPricer for coupons (or the instrument one) and you will again see value in a zero floor.

Either way MAKE VERY SURE that you have the correct yoy inflation volatility for the pricing engine!  Don't use a Black vol in a UnitDisplaced pricer/engine or you will have incorrect results.  If you are starting from cap/floor prices on BBG (or wherever) you have to strip with the same type of pricer that you then price with.  Of course, there is a smile in the market data on BBG :-) so ...

Usual disclaimers apply. 

Best,
Chris

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