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Volatility Interpolation

11 Pages Posted: 21 Oct 2010 Last revised: 30 Oct 2010

Jesper Andreasen

Danske Bank - Danske Markets

Brian Norsk Huge

Danske Bank

Date Written: March 20, 2010

Abstract

We present an effcient algorithm for interpolation and extrapolation of a discrete set of European option prices into a an arbitrage consistent full double continuum in expiry and strike of option prices. The method is based on an application of the fully implicit finite difference method and related to the local variance gamma model of Carr (2008). In a numerical example we show how the model can fitted to all quoted prices in the SX5E option market (12 expiries, each with roughtly 10 strikes) in 0.05 seconds of CPU time.

Keywords: Option pricing, implicit finite difference

JEL Classification: G12, G13

Suggested Citation

Andreasen, Jesper and Huge, Brian Norsk, Volatility Interpolation (March 20, 2010). Available at SSRN: https://ssrn.com/abstract=1694972 or http://dx.doi.org/10.2139/ssrn.1694972

Jesper Andreasen (Contact Author)

Danske Bank - Danske Markets ( email )

Holmens Kanal 2-12
DK-1092 Copenhagen K
Denmark

Brian Norsk Huge

Danske Bank ( email )

DK-1092 Copenhagen K
Denmark

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