We note that the option price depends critically on the HW volatility level. We develop a technique to calibrate the HW volatility for GIC pricing. The idea is to associate a European swaption specification to the particular GIC specification. The HW volatility can then be determined by matching the HW model price for the swaption to the swaption's market price. We note that this technique may be highly sensitive to the selection of the associated swaption; moreover, this selection must reflect the hedging strategy for the GIC embedded option.

If an American swaption is exercised at a point that is not a reset date, in practice, the effective Libor rate at the point of exercise is a blended rate, which is linearly interpolated from a pair of Libor rates with respective accrual periods that bracket the remaining time interval to the next reset date. The effective Libor rate at the exercise point is taken to be the simple interest rate implied from the zero-coupon bond price to the next reset date. This treatment represents a compromise between accuracy and computational efficiency, since it avoids having to determine bracketing Libor rate values.

Financial data are known to be far from normal and replete with outliers, many of which result from “dirty” data – data that contain errors. Such errors introduce extreme or aberrant data points, which can significantly distort parameter estimation results. Therefore, robust estimations are required to achieve stable and accurate results.

There are two types of returns calculated during calibration depending on whether the risk factor is an absolute risk factor or relative risk factor. In addition, certain types of commodity risk factors require special treatment near the time of contract expiry - a process referred to as roll-over adjustment.