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How to make Dupire's local volatility work with jumps


  • Peter K. Friz
  • Stefan Gerhold
  • Marc Yor


There are several (mathematical) reasons why Dupire's formula fails in the non-diffusion setting. And yet, in practice, ad-hoc preconditioning of the option data works reasonably well. In this note we attempt to explain why. In particular, we propose a regularization procedure of the option data so that Dupire's local vol diffusion process recreates the correct option prices, even in manifest presence of jumps.

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  • Peter K. Friz & Stefan Gerhold & Marc Yor, 2013. "How to make Dupire's local volatility work with jumps," Papers 1302.5548,
  • Handle: RePEc:arx:papers:1302.5548

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    References listed on IDEAS

    1. Peter Carr & Helyette Geman & Dilip Madan & Marc Yor, 2004. "From local volatility to local Levy models," Quantitative Finance, Taylor & Francis Journals, vol. 4(5), pages 581-588.
    2. Rama Cont & Ekaterina Voltchkova, 2005. "Integro-differential equations for option prices in exponential Lévy models," Finance and Stochastics, Springer, vol. 9(3), pages 299-325, July.
    3. repec:dau:papers:123456789/1448 is not listed on IDEAS
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