On Estimation of Volatility Surface and Prediction of Future Spot Volatility

Fima Klebaner, Truc Le and Robert Liptser

Applied Mathematical Finance, 2006, vol. 13, issue 3, 245-263

Abstract: A stochastic process v(t) is considered as a model for asset's spot volatility. A new approach is introduced for predicting future spot volatility and future volatility surface using a finite set of observed option prices. When the volatility parameter σ2 in the Black-Scholes formula[image omitted] is represented by the integrated volatility [image omitted] , then the local volatility surface can be estimated. The main idea is to linearize the expressions for implied volatility by using a result on Normal correlation. This linearization is obtained by introducing various ad hoc approximations.

Date: 2006
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DOI: 10.1080/13504860600564661

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