Analytical approximation of the transition density in a local volatility model (Q432231): Difference between revisions
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Property / author: Andrea Pascucci / rank | |||
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The paper is mainly concerned with one-dimensional local volatility market models of the form \[ \text{d}S_t=\mu(t, S_t)\text{d} t+\sigma(t, S_t)S_t\text{d}W_t. \] Exploiting the analytical approximation of function \(\sigma\) the authors obtain an expansion of the transition density \(\Gamma(t, S_0; T, S)\) of \(S\) of the form \[ \Gamma(t, S_0; T, S)\approx \Gamma^0(t, S_0; T, S)+\sum_{n=1}^NJ_{S_0}^n\Gamma^0(t, S_0; T, S), \quad N\geq1, \] where the main term \(\Gamma^0(t, S_0; T, S)\) is the density in a suitable Black-Scholes model, while \(J_{S_0}^n\) is a differential operator containing derivatives w.r.t. \(S_0\). This is the expansion in terms of BS-Greeks. An iterative algorithm for the explicit expressions of the operators \(J_{S_0}^n\) is constructed. This algorithm is straightforward to implement by using a symbolic computation software. The analytical approximation formulae are tested with a Monte-Carlo simulation in the context of one-dimensional local volatility models (standard quadratic and CEV). | |||
Property / review text: The paper is mainly concerned with one-dimensional local volatility market models of the form \[ \text{d}S_t=\mu(t, S_t)\text{d} t+\sigma(t, S_t)S_t\text{d}W_t. \] Exploiting the analytical approximation of function \(\sigma\) the authors obtain an expansion of the transition density \(\Gamma(t, S_0; T, S)\) of \(S\) of the form \[ \Gamma(t, S_0; T, S)\approx \Gamma^0(t, S_0; T, S)+\sum_{n=1}^NJ_{S_0}^n\Gamma^0(t, S_0; T, S), \quad N\geq1, \] where the main term \(\Gamma^0(t, S_0; T, S)\) is the density in a suitable Black-Scholes model, while \(J_{S_0}^n\) is a differential operator containing derivatives w.r.t. \(S_0\). This is the expansion in terms of BS-Greeks. An iterative algorithm for the explicit expressions of the operators \(J_{S_0}^n\) is constructed. This algorithm is straightforward to implement by using a symbolic computation software. The analytical approximation formulae are tested with a Monte-Carlo simulation in the context of one-dimensional local volatility models (standard quadratic and CEV). / rank | |||
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Property / reviewed by: Nikita E. Ratanov / rank | |||
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Property / Mathematics Subject Classification ID: 91G20 / rank | |||
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Property / Mathematics Subject Classification ID: 91B26 / rank | |||
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Property / Mathematics Subject Classification ID: 35Q91 / rank | |||
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Property / Mathematics Subject Classification ID: 35K10 / rank | |||
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Property / Mathematics Subject Classification ID: 60J70 / rank | |||
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Property / Mathematics Subject Classification ID: 91G60 / rank | |||
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Property / zbMATH DE Number: 6052605 / rank | |||
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local volatility | |||
Property / zbMATH Keywords: local volatility / rank | |||
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analytical approximation | |||
Property / zbMATH Keywords: analytical approximation / rank | |||
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heat kernel expansion | |||
Property / zbMATH Keywords: heat kernel expansion / rank | |||
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Black-Scholes formula | |||
Property / zbMATH Keywords: Black-Scholes formula / rank | |||
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transition density | |||
Property / zbMATH Keywords: transition density / rank | |||
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Revision as of 00:09, 30 June 2023
scientific article
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English | Analytical approximation of the transition density in a local volatility model |
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Analytical approximation of the transition density in a local volatility model (English)
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3 July 2012
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The paper is mainly concerned with one-dimensional local volatility market models of the form \[ \text{d}S_t=\mu(t, S_t)\text{d} t+\sigma(t, S_t)S_t\text{d}W_t. \] Exploiting the analytical approximation of function \(\sigma\) the authors obtain an expansion of the transition density \(\Gamma(t, S_0; T, S)\) of \(S\) of the form \[ \Gamma(t, S_0; T, S)\approx \Gamma^0(t, S_0; T, S)+\sum_{n=1}^NJ_{S_0}^n\Gamma^0(t, S_0; T, S), \quad N\geq1, \] where the main term \(\Gamma^0(t, S_0; T, S)\) is the density in a suitable Black-Scholes model, while \(J_{S_0}^n\) is a differential operator containing derivatives w.r.t. \(S_0\). This is the expansion in terms of BS-Greeks. An iterative algorithm for the explicit expressions of the operators \(J_{S_0}^n\) is constructed. This algorithm is straightforward to implement by using a symbolic computation software. The analytical approximation formulae are tested with a Monte-Carlo simulation in the context of one-dimensional local volatility models (standard quadratic and CEV).
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local volatility
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analytical approximation
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heat kernel expansion
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Black-Scholes formula
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transition density
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