New Approximations in Local Volatility Models

Abstract

For general time-dependent local volatility models, we propose new ap- proximation formulas for the price of call options. This extends previous results of [BGM10b] where stochastic expansions combined with Malliavin calculus were performed to obtain approximation formulas based on the local volatility At The Money. Here, we derive alternative expansions involving the local volatility at strike. Averaging both expansions give even more accurate results. Approximations of the implied volatility are provided as well.

Keywords: Local volatility model, European option, asymptotic expansion, CEV model