Volatility in options formulae for general stochastic dynamics

DOI10.3934/DCDSB.2014.19.435MaRDI QIDQ2438860zbMATH OpenOpenAlexWikidataFDO

Authors K. Hamza, Fima Klebaner, Olivia Mah

Publication date 7 March 2014

Published in Discrete and Continuous Dynamical Systems. Series B (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1306.0980

zbMATH Keywords

Black-Scholes modelimplied volatility

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Martingales with continuous parameter (60G44) Applications of stochastic analysis (to PDEs, etc.) (60H30) Stochastic models in economics (91B70)

Abstract: It is well-known that the Black-Scholes formula has been derived under the assumption of constant volatility in stocks. In spite of evidence that this parameter is not constant, this formula is widely used by financial markets. This paper addresses the question of whether an alternative model for stock price exists for which the Black-Scholes or similar formulae hold. The results obtained in this paper are very general as no assumptions are made on the dynamics of the model, whether it be the underlying price process, the volatility process or how they relate to each other. We show that if the formula holds for a continuum of strikes and three terminal times, then the volatility must be constant. However, when it only holds for finitely many strikes, and three or more maturity times, we obtain a universal bound on the variation of the volatility. This bound yields that the implied volatility is constant when the sequence of strikes increases to cover the entire half-line. This recovers the result for a continuum of strikes by a different approach.

Recommendations

• scientific article; zbMATH DE number 2163514
• On the implicit Black–Scholes formula
• Robustness of the Black and Scholes Formula
• An explicit implied volatility formula
• Equivalent Black volatilities

Cites work

• scientific article; zbMATH DE number 51724 (Why is no real title available?)
• Generalized Ito's formula and additive functionals of Brownian motion
• On nonexistence of non-constant volatility in the Black-Scholes formula
• On the implicit Black–Scholes formula
• Stopping times and tightness
• The equivalent martingale measure conditions in a general model for interest rates

Cited in

(7)

• Can there be an explicit formula for implied volatility?
• Volatility and expected option returns: a note
• Uniform bounds for Black-Scholes implied volatility
• The instantaneous volatility and the implied volatility surface for a generalized Black-Scholes model
• INTEGRAL REPRESENTATION OF PROBABILITY DENSITY OF STOCHASTIC VOLATILITY MODELS AND TIMER OPTIONS
• scientific article; zbMATH DE number 2163514 (Why is no real title available?)
• Variational Analysis for Options with Stochastic Volatility and Multiple Factors

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