From characteristic functions to implied volatility expansions
Computational Finance
2014-06-26 v5 General Finance
Pricing of Securities
Abstract
For any strictly positive martingale for which has a characteristic function, we provide an expansion for the implied volatility. This expansion is explicit in the sense that it involves no integrals, but only polynomials in the log strike. We illustrate the versatility of our expansion by computing the approximate implied volatility smile in three well-known martingale models: one finite activity exponential L\'evy model (Merton), one infinite activity exponential L\'evy model (Variance Gamma), and one stochastic volatility model (Heston). Finally, we illustrate how our expansion can be used to perform a model-free calibration of the empirically observed implied volatility surface.
Cite
@article{arxiv.1207.0233,
title = {From characteristic functions to implied volatility expansions},
author = {Antoine Jacquier and Matthew Lorig},
journal= {arXiv preprint arXiv:1207.0233},
year = {2014}
}
Comments
21 pages, 4 figures