Online local volatility calibration by convex regularization

Vinicius Albani, Jorge P. Zubelli

Research output: Contribution to journalArticlepeer-review

9 Scopus citations

Abstract

We address the inverse problem of local volatility surface calibration from market given option prices. We integrate the ever-increasing flow option price information into the well-accepted local volatility model of Dupire. This leads to considering both the local volatility surfaces and their corresponding prices as indexed by the observed underlying stock price as time goes by in appropriate function spaces. The resulting parameter to data map is defined in appropriate Bochner-Sobolev spaces. Under this framework, we prove key regularity properties. This enables us to build a calibration technique that combines online methods with convex Tikhonov regularization tools. Such procedure is used to solve the inverse problem of local volatility identifi-cation. As a result, we prove convergence rates with respect to noise and a corresponding discrepancy-based choice for the regularization parameter. We conclude by illustrating the theoretical results by means of numerical tests.

Original languageBritish English
Pages (from-to)243-268
Number of pages26
JournalApplicable Analysis and Discrete Mathematics
Volume8
Issue number2
DOIs
StatePublished - 2014

Keywords

  • Convergence rates
  • Convex regularization
  • Local volatility calibration
  • Morozov's principle
  • Online estimation

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