On the harmonic mean representation of the implied volatility

DOI10.1137/20M1352120zbMATH Open1461.91311arXiv2007.03585MaRDI QIDQ4988554FDOQ4988554

Authors: Stefano De Marco 

Publication date: 17 May 2021

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

Abstract: It is well know that, in the short maturity limit, the implied volatility approaches the integral harmonic mean of the local volatility with respect to log-strike, see [Berestycki et al., Asymptotics and calibration of local volatility models, Quantitative Finance, 2, 2002]. This paper is dedicated to a complementary model-free result: an arbitrage-free implied volatility in fact is the harmonic mean of a positive function for any fixed maturity. We investigate the latter function, which is tightly linked to Fukasawa's invertible map $f_{1/2}$ [Fukasawa, The normalizing transformation of the implied volatility smile, Mathematical Finance, 22, 2012], and its relation with the local volatility surface. It turns out that the log-strike transformation $z=f_{1/2}(k)$ defines a new coordinate system in which the short-dated implied volatility approaches the arithmetic (as opposed to harmonic) mean of the local volatility. As an illustration, we consider the case of the SSVI parameterization: in this setting, we obtain an explicit formula for the volatility swap from options on realized variance.

Full work available at URL: https://arxiv.org/abs/2007.03585

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zbMATH Keywords

harmonic meanlocal volatilityimplied volatilitymodel-free properties

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Harmonic analysis in one variable (42A99)

Cites Work

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