Calibration Design of Implied Volatility Surfaces
AbstractThe calibration of option pricing models leads to the minimization of an error functional. We show that its usual specification as a root mean squared error implies fluctuating exotics prices and possibly wrong prices. We propose a simple and natural method to overcome these problems, illustrate drawbacks of the usual approach and show advantages of our method. To this end, we calibrate the Heston model to a time series of DAX implied volatility surfaces and then price cliquet options.
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Bibliographic InfoPaper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-002.
Length: 12 pages
Date of creation: Jan 2006
Date of revision:
calibration; data design; implied volatility surface; Heston model; cliquet option;
Find related papers by JEL classification:
- C80 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - General
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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- Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-43.
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