The equivalent constant-elasticity-of-variance (CEV) volatility of the stochastic-alpha-beta-rho (SABR) model

Jaehyuk Choi and Lixin Wu

Papers from arXiv.org

Abstract: This study presents new analytic approximations of the stochastic-alpha-beta-rho (SABR) model. Unlike existing studies that focus on the equivalent Black-Scholes (BS) volatility, we instead derive the equivalent constant-elasticity-of-variance (CEV) volatility. Our approach effectively reduces the approximation error in a way similar to the control variate method because the CEV model is the zero vol-of-vol limit of the SABR model. Moreover, the CEV volatility approximation yields a finite value at a zero strike and thus conveniently leads to a small-time asymptotics for the mass at zero. The numerical results compare favorably with the BS volatility approximations in terms of the approximation accuracy, small-strike volatility asymptotics, and no-arbitrage region.

Date: 2019-11, Revised 2021-06
New Economics Papers: this item is included in nep-ore and nep-rmg
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Citations: View citations in EconPapers (4)

Published in Journal of Economic Dynamics and Control, 128:104143, 2021

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Journal Article: The equivalent constant-elasticity-of-variance (CEV) volatility of the stochastic-alpha-beta-rho (SABR) model (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1911.13123

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