Imposing no‐arbitrage conditions in implied volatilities using constrained smoothing splines

Márcio Laurini

Applied Stochastic Models in Business and Industry, 2011, vol. 27, issue 6, 649-659

Abstract: We apply constrained smoothing B‐splines to the construction of arbitrage‐free implied volatilities and derived measures. The constrained smoothing B‐splines allows the imposition of the constraints of monotonicity and convexity given by the no‐arbitrage conditions in the pricing function. We illustrate the methodology in the construction of implied volatilities and also in the construction of derived measures such as risk‐neutral densities, showing that it can be used as an effective tool for general treatment of option prices. Copyright © 2011 John Wiley & Sons, Ltd.

Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:wly:apsmbi:v:27:y:2011:i:6:p:649-659

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