Shapes of implied volatility with positive mass at zero

DOI10.1137/14098065XMaRDI QIDQ4607048zbMATH OpenFDO

Authors Stefano De Marco, Antoine Jacquier, Caroline Hillairet

Publication date 12 March 2018

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

Full work available at URL https://arxiv.org/abs/1310.1020

zbMATH Keywords

absorption at zeroatomic distributionCEV modelheavy-tailed distributionimplied volatilitysmile asymptotics

Mathematics Subject Classification ID

Statistics of extreme values; tail inference (62G32) Applications of statistics to actuarial sciences and financial mathematics (62P05) Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60)

Abstract: We study the shapes of the implied volatility when the underlying distribution has an atom at zero and analyse the impact of a mass at zero on at-the-money implied volatility and the overall level of the smile. We further show that the behaviour at small strikes is uniquely determined by the mass of the atom up to high asymptotic order, under mild assumptions on the remaining distribution on the positive real line. We investigate the structural difference with the no-mass-at-zero case, showing how one can--theoretically--distinguish between mass at the origin and a heavy-left-tailed distribution. We numerically test our model-free results in stochastic models with absorption at the boundary, such as the CEV process, and in jump-to-default models. Note that while Lee's moment formula tells that implied variance is at most asymptotically linear in log-strike, other celebrated results for exact smile asymptotics such as Benaim and Friz (09) or Gulisashvili (10) do not apply in this setting--essentially due to the breakdown of Put-Call duality.

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Cited in

(19)

• The equivalent constant-elasticity-of-variance (CEV) volatility of the stochastic-alpha-beta-rho (SABR) model
• A Black-Scholes inequality: applications and generalisations
• Uniform bounds for Black-Scholes implied volatility
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• A general moment formula
• Tighter `uniform bounds for Black-Scholes implied volatility' and the applications to root-finding

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