Calibrating a Diffusion Pricing Model with Uncertain Volatility: Regularization and Stability

Dominick Samperi

Mathematical Finance, 2002, vol. 12, issue 1, 71-87

Abstract: A regularized (smoothed) version of the model calibration method of Avellaneda, Friedman, Holmes, and Samperi (1997) is studied. We prove that the regularized formulation is solvable and that the solution depends continuously on the input data (observed derivative security prices). Associated issues of model credibility, stability, and robustness (insensitivity to model assumptions) are discussed. The Implicit Function Theorem for Banach spaces is used for the stability proof, and some numerical illustrations are included.

Date: 2002
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