Model-free stochastic collocation for an arbitrage-free implied volatility, part II
Risks , Volume 7 - Issue 1 p. 1- 23
This paper explores the stochastic collocation technique, applied on a monotonic spline, as an arbitrage-free and model-free interpolation of implied volatilities. We explore various spline formulations, including B-spline representations. We explain how to calibrate the different representations against market option prices, detail how to smooth out the market quotes, and choose a proper initial guess. The technique is then applied to concrete market options and the stability of the different approaches is analyzed. Finally, we consider a challenging example where convex spline interpolations lead to oscillations in the implied volatility and compare the spline collocation results with those obtained through arbitrage-free interpolation technique of Andreasen and Huge.
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|Organisation||Centrum Wiskunde & Informatica, Amsterdam, The Netherlands|
Le Floc’h, F.L, & Oosterlee, C.W. (2019). Model-free stochastic collocation for an arbitrage-free implied volatility, part II. Risks, 7(1), 1–23. doi:10.3390/risks7010030