Local volatility models in commodity markets and online calibration

Vinicius Albani, Uri M. Ascher, Jorge P. Zubelli

Research output: Contribution to journalArticlepeer-review

3 Scopus citations

Abstract

We introduce a local volatility model for the valuation of options on commodity futures by using European vanilla option prices. The corresponding calibration problem is addressed within an online framework, allowing the use of multiple price surfaces. Since uncertainty in the observation of the underlying future prices translates to uncertainty in data locations, we propose a model-based adjustment of such prices that improves reconstructions and smile adherence. In order to tackle the illposedness of the calibration problem we incorporate a priori information through a judiciously designed Tikhonov-type regularization. Extensive empirical tests with market and synthetic data are used to demonstrate the effectiveness of the methodology and algorithms.

Original languageBritish English
Pages (from-to)63-95
Number of pages33
JournalJournal of Computational Finance
Volume21
Issue number5
DOIs
StatePublished - Apr 2018

Keywords

  • Commodity future options
  • Inverse problem
  • Local volatility calibration
  • Online approach
  • Tikhonov-type regularization

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