Model-free stochastic collocation for an arbitrage-free implied volatility, part I
This paper explains how to calibrate a stochastic collocation polynomial against market option prices directly. The method is first applied to the interpolation of short-maturity equity option prices in a fully arbitrage-free manner and then to the joint calibration of the constant maturity swap convexity adjustments with the interest rate swaptions smile. To conclude, we explore some limitations of the stochastic collocation technique.
|Journal||Decisions in Economics and Finance|
Le Floc’h, F.L, & Oosterlee, C.W. (2019). Model-free stochastic collocation for an arbitrage-free implied volatility, part I. Decisions in Economics and Finance, 42, 679–714. doi:10.1007/s10203-019-00238-x