Calibration of Stochastic Volatility Models: An Optimal Control Approach
26 Pages Posted: 21 Oct 2012
Date Written: April 30, 2012
We aim to calibrate stochastic volatility models from option prices. We develop an optimal control approach to recover the risk neutral drift term of stochastic volatility. An efficient numerical algorithm is given. Numerical results and empirical studies are presented to demonstrate our algorithm. In contrast to existing literature, we do not assume that the stochastic volatility model has special structure, so our algorithm applies to calibration of general stochastic volatility models. In addition, our empirical results reveal that the risk neutral process of volatility recovered from market prices of options on S&P $500$ index is indeed linearly mean-reverting.
Keywords: calibration, stochastic volatility model, option prices, optimal control, inverse problem
JEL Classification: G12, G13
Suggested Citation: Suggested Citation