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You Don't Have to Bother Newton for Implied Volatility

Minqiang Li

Bloomberg LP

November, 2006

The Black-Scholes formula is often used in the backward direction to invert the implied volatility, usually with some solver method. Solver methods, being aesthetically unappealing, are also slower than closed-form approximations. However, closed-form approximations in previous works lack accuracy, often providing option pricing errors well exceeding the bid-ask spreads. We develop a new closed-form method based on the rational approximation. By exploiting the homogeneity in the Black-Scholes formula, we are able to show explicitly our domain of approximation and investigate thoroughly the accuracy of our method. The rational approximation is much faster than typical solver methods and very accurate for both at-the-money and away-from-the-money options. Its accuracy can be further improved by one or two steps of Newton-Raphson iterations.

Number of Pages in PDF File: 28

Keywords: Implied volatility, Black-Scholes formula, rational approximation

JEL Classification: C63, G12, G13

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Date posted: December 20, 2006  

Suggested Citation

Li, Minqiang, You Don't Have to Bother Newton for Implied Volatility (November, 2006). Available at SSRN: https://ssrn.com/abstract=952727 or http://dx.doi.org/10.2139/ssrn.952727

Contact Information

Minqiang Li (Contact Author)
Bloomberg LP ( email )
731 Lexington Avenue
New York, NY 10022
United States

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