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Latent Flow Matching for Arbitrage-Aware Implied Volatility Surface Generation

Computational Finance 2026-08-01 v1 Mathematical Finance

Abstract

We propose an arbitrage-aware latent flow-matching framework for unconditional implied volatility surface generation. The method first compresses high-dimensional surfaces into a low-dimensional latent space using a variational autoencoder regularized by differentiable calendar-spread, call-spread and butterfly-arbitrage penalties. A flow-matching model then learns to transport a Gaussian prior toward the empirical latent distribution, and generated latent samples are decoded back into volatility surfaces. We evaluate the approach using marginal and surface-level Wasserstein distances, smile and skew diagnostics, pointwise quantile surfaces, financially interpretable shape metrics, and static no-arbitrage tests. The proposed model closely reproduces the empirical distribution and the main maturity-moneyness structures, achieves the best performance in the extreme Q99 regime, and generates 90.8% of surfaces satisfying all tested static no-arbitrage conditions. Overall, the results show that latent flow matching provides a favorable balance between distributional similarity, tail preservation, and financial consistency without requiring post-sampling reweighting.

Cite

@article{arxiv.2608.00616,
  title  = {Latent Flow Matching for Arbitrage-Aware Implied Volatility Surface Generation},
  author = {Oscar Brooks and Dusica Bajalica and Yating Lui and Imen Ben Tahar},
  journal= {arXiv preprint arXiv:2608.00616},
  year   = {2026}
}