Practical Applications and Testing

David Nicolay ()

Chapter Chapter 4 in Asymptotic Chaos Expansions in Finance, 2014, pp 211-270 from Springer

Abstract: Abstract In this chapter we turn to even more practical considerations, by applying ACE results to some popular stochastic (instantaneous) volatility models, namely the SABR and FL-SV classes. We start by discussing the financial, practical and numerical issues involved. We then derive the chaos dynamics of each model, up to the third layer, stressing the technical benefits of staying model-generic and of exploiting induction. We can then express the desired static IATM differentials, which we subsequently use in either direct or inverse mode. In inverse fashion, we use those quantities to illustrate an “intuitive” model re-parametrisation of the generic SABR class. In direct mode, we test the flexibility and quality of static smile approximations provided by ACE for the CEV-SABR model, compared to Hagan et al’s benchmark.

Keywords: Stochastic Volatility; Stochastic Volatility Model; Central Configuration; Chaos Dynamic; Negative Density (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:spr:sprfcp:978-1-4471-6506-4_4

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DOI: 10.1007/978-1-4471-6506-4_4

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