Volatility estimation from observed option prices
This paper provides a numerical procedure for calibrating the evolution of the underlying to the volatility smile with respect to, simultaneously, time and strike. The market is supposed to calculate prices by means of \[ dS= S(\mu(S,t)\, dt+ \sigma(S,t)\, dW_t). \] The market ``only informs us of the prices of options. In other words, it is given \(C(K,T)\), the price of the call with strike \(K\) and maturity \(T\), for a finite set of values of \(K\) and \(T\) and we would like to known \(\sigma(S,t)\). It is well known (Dupire) that \(C(K,T)\) satisfies an equation of the form \[ \frac{1}{2} \sigma^2 \frac{\partial^2C}{\partial K^2}= \frac{\partial C}{\partial T}+ A(T)C+ \biggl(B(T)+ \frac{1}{2} \sigma^2\biggr) \frac{\partial C}{\partial K},\tag{1} \] for some known functions \(A\), \(B\) (depending on dividend yield and interest rate). The numerical procedure goes as follows: Given that \(C\) is known at the corners of a certain grid, one transforms a discrete version of (1) into a nonlinear equation whose variable is the value of \(\sigma\) at a nearby point. This approach of the authors is a variation of a previous algorithm of Andersen and Brotherson-Ratcliffe.
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- Recovery of time-dependent parameters of a Black-Scholes-type equation: an inverse Stieltjes moment approach
- Identifying the volatility of underlying assets from option prices
- On martingale diffusions describing the `smile-effect' for implied volatilities
- Realized volatility forecasting and option pricing
- VOLATILITY SMILE BY MULTILEVEL LEAST SQUARE
- A NEW REPRESENTATION OF THE LOCAL VOLATILITY SURFACE
- Estimation of the local volatility of discount bonds using market quotes for coupon-bond options.
- Calibration of the temporally varying volatility and interest rate functions
- TARGET VOLATILITY OPTION PRICING
- Model‐based quantification of the volatility of options at transaction level with extended count regression models
- Numerical Procedure for Calibration of Volatility with American Options
- Evaluating volatility forecasts in option pricing in the context of a simulated options market
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