Simulation of implied volatility surfaces via tangent Lévy models

DOI10.1137/15M1015510MaRDI QIDQ5266358zbMATH OpenOpenAlexFDO

Authors Yi Ma, Sergey Nadtochiy, René Carmona

Publication date 2 June 2017

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

Full work available at URL https://arxiv.org/abs/1504.00334

zbMATH Keywords

implied volatilitymarket-based modelsMonte Carlo simulationportfolio optimizationtangent Lévy models

Mathematics Subject Classification ID

Processes with independent increments; Lévy processes (60G51) Monte Carlo methods (65C05) Portfolio theory (91G10) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Statistical methods; risk measures (91G70)

Abstract: In this paper, we implement and test two types of market-based models for European-type options, based on the tangent Levy models proposed recently by R. Carmona and S. Nadtochiy. As a result, we obtain a method for generating Monte Carlo samples of future paths of implied volatility surfaces. These paths and the surfaces themselves are free of arbitrage, and are constructed in a way that is consistent with the past and present values of implied volatility. We use a real market data to estimate the parameters of these models and conduct an empirical study, to compare the performance of market-based models with the performance of classical stochastic volatility models. We choose the problem of minimal-variance portfolio choice as a measure of model performance and compare the two tangent Levy models to SABR model. Our study demonstrates that the tangent Levy models do a much better job at finding a portfolio with smallest variance, their predictions for the variance are more reliable, and the portfolio weights are more stable. To the best of our knowledge, this is the first example of empirical analysis that provides a convincing evidence of the superior performance of the market-based models for European options using real market data.

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Cites work

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Cited in

(6)

• Tangent Lévy market models
• ROBUST TRADING OF IMPLIED SKEW
• scientific article; zbMATH DE number 5524714 (Why is no real title available?)
• Simulation of Arbitrage-Free Implied Volatility Surfaces
• FuNVol: multi-asset implied volatility market simulator using functional principal components and neural SDEs
• The implied volatility surface (also) is path-dependent

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