Realized Local Volatility Surface

Yuming Ma, Shintaro Sengoku and Kazuhide Nakata

Papers from arXiv.org

Abstract: For quantitative trading risk management purposes, we present a novel idea: the realized local volatility surface. Concisely, it stands for the conditional expected volatility when sudden market behaviors of the underlying occur. One is able to explore risk management usages by following the orthotical Delta-Gamma dynamic hedging framework. The realized local volatility surface is, mathematically, a generalized Wiener measure from historical prices. It is reconstructed via employing high-frequency trading market data. A Stick-Breaking Gaussian Mixture Model is fitted via Hamiltonian Monte Carlo, producing a local volatility surface with 95% credible intervals. A practically validated Bayesian nonparametric estimation workflow. Empirical results on TSLA high-frequency data illustrate its ability to capture counterfactual volatility. We also discuss its application in improving volatility-based risk management.

Date: 2025-04, Revised 2025-04
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Published in The Journal of Investment Strategies, Vol.12, No.1, March 2023, pp.1-21

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