Implied volatility in strict local martingale models

DOI10.1137/16M1069651MaRDI QIDQ4635246zbMATH OpenOpenAlexFDO

Authors Antoine Jacquier, Martin Keller-Ressel

Publication date 16 April 2018

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

Full work available at URL https://arxiv.org/abs/1508.04351

zbMATH Keywords

asymptotic methodsimplied volatilityasset price bubblesstrict local martingale

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Statistical methods; risk measures (91G70) Asymptotic approximations, asymptotic expansions (steepest descent, etc.) (41A60) Generalizations of martingales (60G48)

Abstract: We consider implied volatilities in asset pricing models, where the discounted underlying is a strict local martingale under the pricing measure. Our main result gives an asymptotic expansion of the right wing of the implied volatility smile and shows that the strict local martingale property can be determined from this expansion. This result complements the well-known asymptotic results of Lee and Benaim-Friz, which apply only to true martingales. This also shows that `price bubbles' in the sense of strict local martingale behaviour can in principle be detected by an analysis of implied volatility. Finally we relate our results to left-wing expansions of implied volatilities in models with mass at zero by a duality method based on an absolutely continuous measure change.

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Cited in

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• On the Skew and Curvature of the Implied and Local Volatilities
• Forward implied volatility expansion in time-dependent local volatility models
• Testing the martingale restriction for option implied densities
• A Black-Scholes inequality: applications and generalisations
• Long-time large deviations for the multiasset Wishart stochastic volatility model and option pricing
• Shapes of implied volatility with positive mass at zero
• The log‐moment formula for implied volatility
• Generalized arbitrage-free SVI volatility surfaces
• Uniform bounds for Black-Scholes implied volatility
• Detecting asset price bubbles using deep learning
• Implied Volatility from Local Volatility: A Path Integral Approach
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