Calibration of a hybrid local-stochastic volatility stochastic rates model with a control variate particle method

DOI10.1137/17M1114570zbMATH Open1411.91618arXiv1701.06001OpenAlexW2963090378WikidataQ128298838 ScholiaQ128298838MaRDI QIDQ5742499FDOQ5742499

Authors: Andrei Cozma, Matthieu Mariapragassam, C. Reisinger 

Publication date: 14 May 2019

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

Abstract: We propose a novel and generic calibration technique for four-factor foreign-exchange hybrid local-stochastic volatility models with stochastic short rates. We build upon the particle method introduced by Guyon and Labord`ere [Nonlinear Option Pricing, Chapter 11, Chapman and Hall, 2013] and combine it with new variance reduction techniques in order to accelerate convergence. We use control variates derived from a calibrated pure local volatility model, a two-factor Heston-type LSV model (both with deterministic rates), and the stochastic (CIR) short rates. The method can be applied to a large class of hybrid LSV models and is not restricted to our particular choice of the diffusion. The calibration procedure is performed on real-world market data for the EUR-USD currency pair and has a comparable run-time to the PDE calibration of a two-factor LSV model alone.

Full work available at URL: https://arxiv.org/abs/1701.06001

Recommendations

• Calibrating local volatility models with stochastic drift and diffusion
• Calibration of local volatility using the local and implied instantaneous variance
• Calibration of local volatility model with stochastic interest rates by efficient numerical PDE methods
• Calibration of local‐stochastic volatility models by optimal transport
• A multivariate stochastic volatility model with applications in the foreign exchange market

zbMATH Keywords

particle methodcalibrationcontrol variateFokker-Planck equationHeston-type local-stochastic volatility models

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Software, source code, etc. for problems pertaining to game theory, economics, and finance (91-04) Computational methods for stochastic equations (aspects of stochastic analysis) (60H35) Numerical solutions to stochastic differential and integral equations (65C30)

Cites Work

• GSL
• A theory of the term structure of interest rates
• A closed-form solution for options with stochastic volatility with applications to bond and currency options
• Title not available (Why is that?)
• Title not available (Why is that?)
• Title not available (Why is that?)
• Title not available (Why is that?)
• Title not available (Why is that?)
• Title not available (Why is that?)
• A CLASS OF MARKOV PROCESSES ASSOCIATED WITH NONLINEAR PARABOLIC EQUATIONS
• On the Heston model with stochastic interest rates
• Generic pricing of FX, inflation and stock options under stochastic interest rates and stochastic volatility
• Stochastic Volatility With an Ornstein–Uhlenbeck Process: An Extension
• Pricing of foreign exchange options under the Heston stochastic volatility model and CIR interest rates
• Pricing long-dated insurance contracts with stochastic interest rates and stochastic volatility
• Interest rate models -- theory and practice. With smile, inflation and credit
• A deterministic-shift extension of analytically-tractable and time-homogeneous short-rate models
• Title not available (Why is that?)
• Moment explosions in stochastic volatility models
• Derivatives pricing. The classic collection
• The Heston stochastic-local volatility model: efficient Monte Carlo simulation
• Convergence of an Euler scheme for a hybrid stochastic-local volatility model with stochastic rates in foreign exchange markets
• High-order filtered schemes for time-dependent second order HJB equations
• Convergence analysis of the modified Craig-Sneyd scheme for two-dimensional convection-diffusion equations with nonsmooth initial data
• A nonlinear partial integro-differential equation from mathematical finance
• A finite volume-alternating direction implicit approach for the calibration of stochastic local volatility models
• Nonlinear option pricing
• A novel Monte Carlo approach to hybrid local volatility models
• Boundary conditions for computing densities in hybrid models via PDE methods
• Efficient exposure computation by risk factor decomposition

Cited In (12)

• Hybrid equity swap, cap, and floor pricing under stochastic interest by Markov chain approximation
• Generic improvements to least squares Monte Carlo methods with applications to optimal stopping problems
• A finite volume-alternating direction implicit approach for the calibration of stochastic local volatility models
• Pricing of vulnerable options under hybrid stochastic and local volatility
• A new class of multidimensional Wishart-based hybrid models
• Calibration to FX triangles of the 4/2 model under the benchmark approach
• The calibration of stochastic local-volatility models: an inverse problem perspective
• Calibrating local volatility models with stochastic drift and diffusion
• Calibration of local‐stochastic volatility models by optimal transport
• A hybrid Markov-Functional model with simultaneous calibration to the interest rate and FX smile
• Collocating volatility: a competitive alternative to stochastic local volatility models
• Calibration of local volatility model with stochastic interest rates by efficient numerical PDE methods

Uses Software

• GSL
• FEAPpv

This page was built for publication: Calibration of a hybrid local-stochastic volatility stochastic rates model with a control variate particle method

Report a bug (only for logged in users!)Click here to report a bug for this page (MaRDI item Q5742499)