FuNVol: multi-asset implied volatility market simulator using functional principal components and neural SDEs

Vedant Choudhary, Sebastian Jaimungal and Maxime Bergeron

Quantitative Finance, 2024, vol. 24, issue 8, 1077-1103

Abstract: We introduce a new approach for generating sequences of implied volatility (IV) surfaces across multiple assets that are faithful to historical prices. We do so using a combination of functional data analysis and neural stochastic differential equations (SDEs) combined with a probability integral transform penalty to reduce model misspecification. We demonstrate that learning the joint dynamics of IV surfaces and prices produces market scenarios that are consistent with historical features and lie within the sub-manifold of surfaces that are essentially free of static arbitrage. Finally, we demonstrate that delta hedging using the simulated surfaces generates profit and loss (P&L) distributions that are consistent with realized P&Ls.

Date: 2024
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DOI: 10.1080/14697688.2024.2396977

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