An arbitrage-free interpolation of class $C^2$ for option prices

Fabien Le Floc'h

Papers from arXiv.org

Abstract: This paper presents simple formulae for the local variance gamma model of Carr and Nadtochiy, extended with a piecewise-linear local variance function. The new formulae allow to calibrate the model efficiently to market option quotes. On a small set of quotes, exact calibration is achieved under one millisecond. This effectively results in an arbitrage-free interpolation of class $C^2$. The paper proposes a good regularization when the quotes are noisy. Finally, it puts in evidence an issue of the model at-the-money, which is also present in the related one-step finite difference technique of Andreasen and Huge, and gives two solutions for it.

Date: 2020-04, Revised 2020-05
New Economics Papers: this item is included in nep-gen
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