Identification of the local speed function in a Lévy model for option pricing (Q935180)

This paper proposes a non-parametric stable calibration method based on Tikhonov regularization for the local speed function in a local Lévy model. The jump term in this model introduces an operator into the classical Black-Scholes equation such that the associated model calibration to observed option prices can be treated as a parameter identification problem for a partial integro-differential equation. This problem is ill-posed and thus requires regularization. The paper proves that nonlinear Tikhonov regularization is a stable and convergent method. Convergence rates are established and numerical illustrations given.