Inverting the Markovian projection, with an application to local stochastic volatility models

DOI10.1214/19-AOP1420MaRDI QIDQ2212591zbMATH OpenOpenAlexFDO

Authors Daniel Lacker, Mykhaylo Shkolnikov, Jiacheng Zhang

Publication date 24 November 2020

Published in The Annals of Probability (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1905.06213, https://projecteuclid.org/euclid.aop/1600826469

zbMATH Keywords

Fokker-Planck equationslocal stochastic volatilityMarkovian projectionMcKean-Vlasov equationsmimickingnonlinear elliptic equationspathwise uniquenessregularity of invariant measuresstrong solutions

Mathematics Subject Classification ID

Nonlinear elliptic equations (35J60) Fokker-Planck equations (35Q84) Stochastic ordinary differential equations (aspects of stochastic analysis) (60H10) Stochastic models in economics (91B70)

Abstract: We study two-dimensional stochastic differential equations (SDEs) of McKean--Vlasov type in which the conditional distribution of the second component of the solution given the first enters the equation for the first component of the solution. Such SDEs arise when one tries to invert the Markovian projection developed by Gy"ongy (1986), typically to produce an It^o process with the fixed-time marginal distributions of a given one-dimensional diffusion but richer dynamical features. We prove the strong existence of stationary solutions for these SDEs, as well as their strong uniqueness in an important special case. Variants of the SDEs discussed in this paper enjoy frequent application in the calibration of local stochastic volatility models in finance, despite the very limited theoretical understanding.

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Cited in

(18)

• From Bachelier to Dupire via optimal transport
• On the Markovian projection in the Brunick-Shreve mimicking result
• Stationary solutions and local equations for interacting diffusions on regular trees
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• Existence and uniqueness results for strongly degenerate McKean-Vlasov equations with rough coefficients
• Regularity and propagation of chaos for conditional McKean-Vlasov equations
• On the weak error for local stochastic volatility models

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