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APPROXIMATING LOCAL VOLATILITY FUNCTIONS OF STOCHASTIC VOLATILITY MODELS: A CLOSED-FORM EXPANSION APPROACH

Published online by Cambridge University Press:  14 July 2015

Yu An and
Chenxu Li
Yu An
Affiliation:
Graduate School of Business, Stanford University E-mail: yua@stanford.edu
Chenxu Li
Affiliation:
Guanghua School of Management, Peking University E-mail: cxli@gsm.pku.edu.cn
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Abstract

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We propose a method for approximating equivalent local volatility functions of stochastic volatility models. Enlightened by the theory of generalized Wiener functionals proposed by Watanabe and Yoshida (1987, 1992), our key technique is to propose a closed-form expansion of conditional expectations involving marginal distributions generated by stochastic differential equations. A numerical test and an illustration of application are provided to demonstrate the efficiency of our approach.

Information

Type
Research Article
Information
Probability in the Engineering and Informational Sciences , Volume 29 , Issue 4 , October 2015, pp. 547 - 563
Copyright
Copyright © Cambridge University Press 2015 

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