Volatility in options formulae for general stochastic dynamics (Q2438860)

In [Stochastics 80, No. 1, 97--102 (2008; Zbl 1140.60022)] the first two authors proved that if the Black-Scholes formula (with constant volatility) holds for all strikes and at least three maturities, then it must hold for all maturities and all strikes, implying that the implied volatility surface is entirely flat. With the additional assumption that the filtration of the stock price is that of a Brownian motion, the stock price is necessarily Black-Scholes. In the present paper, the authors extend this result in two directions. Their first result is as follows: Theorem: Let \(S\) and \(\theta\) be two adapted processes with \(\theta_0 = \sigma>0\) and \(S_0 = z_0>0\). Let further \(C_{\mathrm{BS}}(t,T,K,\sigma, S_t)\) denote the price of a European call option at time \(t\), with maturity \(T\) and strike \(K\) on the stock price \(S\) in the Black-Scholes model with volatility \(\sigma\). If \(S\) is nonnegative and if \(\mathbb{E}[(S_T-K)_+| \mathcal{F}_t] = C_{\mathrm{BS}}(t,T,K,\theta_t, S_t)\) for all strikes \(K\geq 0\) and at least three maturities \(T\in \{T_1, T_2, T_3\}\), then \(\theta_t = \sigma\) for all \(t\leq T_1\). Furthermore, if \(\mathcal{F}\) is the natural filtration of a Brownian motion \(W\) then, up to \(T_1\), \(S\) is the unique weak solution to \(dS_t = \sigma h(t) \beta(S_t) dW_t\), for some functions \(h\) and \(\beta\). The second extension concerns the case of finitely many strikes. The authors obtain a universal bound on the variation of the volatility, which in particular implies that the implied volatility becomes constant as the sequence of strikes increases to the whole positive half-line.