Asymptotics of Forward Implied Volatility

DOI10.1137/140960712MaRDI QIDQ5250047zbMATH OpenOpenAlexFDO

Authors Antoine Jacquier, Patrick Roome

Publication date 15 May 2015

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1212.0779

zbMATH Keywords

asymptotic expansionforward implied volatilitylarge deviationsstochastic volatilitytime-changed Lévy model

Mathematics Subject Classification ID

Large deviations (60F10) Processes with independent increments; Lévy processes (60G51) Numerical methods (including Monte Carlo methods) (91G60) Financial applications of other theories (91G80)

Abstract: We prove here a general closed-form expansion formula for forward-start options and the forward implied volatility smile in a large class of models, including the Heston stochastic volatility and time-changed exponential L'evy models. This expansion applies to both small and large maturities and is based solely on the properties of the forward characteristic function of the underlying process. The method is based on sharp large deviations techniques, and allows us to recover (in particular) many results for the spot implied volatility smile. In passing we (i) show that the forward-start date has to be rescaled in order to obtain non-trivial small-maturity asymptotics, (ii) prove that the forward-start date may influence the large-maturity behaviour of the forward smile, and (iii) provide some examples of models with finite quadratic variation where the small-maturity forward smile does not explode.

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Cited in

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