From characteristic functions to implied volatility expansions
AbstractFor any strictly positive martingale $S = \exp(X)$ for which $X$ 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.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1207.0233.
Date of creation: Jul 2012
Date of revision: Jun 2014
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-07-14 (All new papers)
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