From Implied to Local Volatility Surface

93 Pages Posted: 26 Jun 2012 Last revised: 15 Jul 2012

See all articles by Daniel Alexandre Bloch

Daniel Alexandre Bloch

Université Paris VI Pierre et Marie Curie

Date Written: June 25, 2012

Abstract

We describe a single parametric model for the entire volatility surface with interpolation and extrapolation technique generating a smooth and robust implied volatility surface without arbitrage in space and time. It is used for marking option prices on indices and single stocks as well as for computing analytically a proper local volatility with smooth risk-neutral density. Greeks and stress scenarios are calculated analytically in the parametric model without recalibration of the model parameters. We perform a simple expansion of the parametric model obtaining an analytic representation of its implied volatility surface along its cone of diffusion. In view of adding control to the generated volatility surface, we modify the model by adding three new parameters producing, in an independent way, a parallel shift, skew shift and curvature shift of that surface along its cone of diffusion. These parameters can be used manually to modify the entire shape of the volatility surface, and can also be used to generate analytically the new local volatility surface when computing the vegas of an option. Then, in view of defining the best possible volatility surface for non-liquid stocks where only few brokers quotes exist, we describe a method combining historical model parameters of the implied volatility surface together with parameters from other liquid stocks observed on the market.

Keywords: Implied Volatility Surface, Local Volatility Surface, Calibration, Single Parametric Model, Analytic Greeks, Analytic Stress Scenarios

Suggested Citation

Bloch, Daniel Alexandre, From Implied to Local Volatility Surface (June 25, 2012). Available at SSRN: https://ssrn.com/abstract=2091117 or http://dx.doi.org/10.2139/ssrn.2091117

Daniel Alexandre Bloch (Contact Author)

Université Paris VI Pierre et Marie Curie ( email )

175 Rue du Chevaleret
Paris, 75013
France

Register to save articles to
your library

Register

Paper statistics

Downloads
856
Abstract Views
3,114
rank
26,860
PlumX Metrics