Each of the models was calibrated to the same family of ATM swaptions that included the 2-yr and the 10-yr underlying swaps with 7 expirations ranging from 6 months to 10 years. All the swaptions were considered equally weighted. Such a setup seems logical in light of the mortgage prepayment option, and the way ADCO models various mortgage indices.

For illustrative purposes, we added a graph for the 7-yr swap and scaled all four lines such that they start at 1. The exhibit supports the Hull-White model, in a spectacular way: volatility index constructed for this model has been the most stable one, by far. This rate plunged by 40% for the year, but the absolute volatility barely changed. The two other models produced volatility indices that were mirror reflective of the rate level. As expected, the lognormal model did the poorest job measuring volatility; the Squared Gaussian model should be kept in mind as we advised last year. If the rates continue their trend, we may need to employ this model.

Since the volatility index comes from our calibration to the ATM swaptions, it reflects the way The Street is thinking: Stay Normal!