Arbitrage-free smoothing of the implied volatility surface
AbstractThe pricing accuracy and pricing performance of local volatility models depends on the absence of arbitrage in the implied volatility surface. An input implied volatility surface that is not arbitrage-free can result in negative transition probabilities and consequently mispricings and false greeks. We propose an approach for smoothing the implied volatility smile in an arbitrage-free way. The method is simple to implement, computationally cheap and builds on the well-founded theory of natural smoothing splines under suitable shape constraints.
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Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Quantitative Finance.
Volume (Year): 9 (2009)
Issue (Month): 4 ()
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Web page: http://www.tandfonline.com/RQUF20
Other versions of this item:
- Matthias R. Fengler, 2005. "Arbitrage-Free Smoothing of the Implied Volatility Surface," SFB 649 Discussion Papers SFB649DP2005-019, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C81 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Methodology for Collecting, Estimating, and Organizing Microeconomic Data
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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