Smart expansion and fast calibration for jump diffusions
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Abstract: Using Malliavin calculus techniques, we derive an analytical formula for the price of European options, for any model including local volatility and Poisson jump process. We show that the accuracy of the formula depends on the smoothness of the payoff function. Our approach relies on an asymptotic expansion related to small diffusion and small jump frequency/size. Our formula has excellent accuracy (the error on implied Black-Scholes volatilities for call option is smaller than 2 bp for various strikes and maturities). Additionally, model calibration becomes very rapid.
The authors use Malliavin calculus techniques to derive an analytic formula for the price of European options, for any model including local volatility and Poisson jump processes. To perform a rigorous analysis, they use a suitable parameterization that is just a tool to derive convenient representations. By using an asymptotic expansion in the context of small diffusions and small jumps (relative to the frequency or to the size), estimates for the derivatives are established. This allows making an explicit contribution at given order and to control the error. It is proved that the accuracy depends on the smoothness of the payoff function. It is also demonstrated that under realistic parameters, the accuracy is good enough, and model calibration becomes very rapid. It is observed that one may use the approximation price and obtain a volatility smile for short maturities and a volatility skew for long maturities.
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Cited in
(33)- Asymptotic expansion of a nonlinear oscillator with a jump-diffusion process
- A decomposition formula for option prices in the Heston model and applications to option pricing approximation
- Double discretization difference schemes for partial integrodifferential option pricing jump diffusion models
- Pricing approximations and error estimates for local Lévy-type models with default
- Positive solutions of European option pricing with CGMY process models using double discretization difference schemes
- The complete Gaussian kernel in the multi-factor Heston model: option pricing and implied volatility applications
- Asymptotic expansion for a Black-Scholes model with small noise stochastic jump-diffusion interest rate
- Pricing discretely monitored barrier options: when Malliavin calculus expansions meet Hilbert transforms
- Hermite expansion of transition densities and European option prices for multivariate diffusions with jumps
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- Expansion formulas for European options in a local volatility model
- Implied volatility of basket options at extreme strikes
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- New approximations in local volatility models
- Approximate indifference pricing in exponential Lévy models
- Expansion formulas for European quanto options in a local volatility FX-LIBOR model
- Approximate option pricing in the Lévy Libor model
- Expansion formulas for bivariate payoffs with application to best-of options on equity and inflation
- Closed-form expansions of discretely monitored Asian options in diffusion models
- Asymptotics of Forward Implied Volatility
- Local stochastic volatility with jumps: analytical approximations
- The VIX Future in Bergomi Models: Fast Approximation Formulas and Joint Calibration with S&P 500 Skew
- Large-maturity regimes of the Heston forward smile
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