English

A General Asymptotic Implied Volatility for Stochastic Volatility Models

Other Condensed Matter 2007-05-23 v2

Abstract

In this paper, we derive a general asymptotic implied volatility at the first-order for any stochastic volatility model using the heat kernel expansion on a Riemann manifold endowed with an Abelian connection. This formula is particularly useful for the calibration procedure. As an application, we obtain an asymptotic smile for a SABR model with a mean-reversion term, called lambda-SABR, corresponding in our geometric framework to the Poincar\'{e} hyperbolic plane. When the lambda-SABR model degenerates into the SABR-model, we show that our asymptotic implied volatility is a better approximation than the classical Hagan-al expression . Furthermore, in order to show the strength of this geometric framework, we give an exact solution of the SABR model with beta=0 or 1. In a next paper, we will show how our method can be applied in other contexts such as the derivation of an asymptotic implied volatility for a Libor market model with a stochastic volatility.

Keywords

Cite

@article{arxiv.cond-mat/0504317,
  title  = {A General Asymptotic Implied Volatility for Stochastic Volatility Models},
  author = {Pierre Henry-Labordere},
  journal= {arXiv preprint arXiv:cond-mat/0504317},
  year   = {2007}
}

Comments

35 pp. References added. Some typos corrected