An Hilbert space approach for a class of arbitrage free implied volatilities models

arXiv0712.1343MaRDI QIDQ6207773FDOQ6207773

Alan Brace, B. Goldys, Giorgio Fabbri

Publication date: 9 December 2007

Abstract: We present an Hilbert space formulation for a set of implied volatility models introduced in cite{BraceGoldys01} in which the authors studied conditions for a family of European call options, varying the maturing time and the strike price $T$ an $K$, to be arbitrage free. The arbitrage free conditions give a system of stochastic PDEs for the evolution of the implied volatility surface ${hatsigma}_t(T,K)$. We will focus on the family obtained fixing a strike $K$ and varying $T$. In order to give conditions to prove an existence-and-uniqueness result for the solution of the system it is here expressed in terms of the square root of the forward implied volatility and rewritten in an Hilbert space setting. The existence and the uniqueness for the (arbitrage free) evolution of the forward implied volatility, and then of the the implied volatility, among a class of models, are proved. Specific examples are also given.

Mathematics Subject Classification ID

Stochastic partial differential equations (aspects of stochastic analysis) (60H15) PDEs with randomness, stochastic partial differential equations (35R60) Infinite-dimensional random dynamical systems; stochastic equations (37L55)

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