Calibration design of implied volatility surfaces

Kai Detlefsen and Wolfgang Härdle

No 2006-002, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: The calibration of option pricing models leads to the minimization of an error functional. We show that its usual specification as a root mean squared error implies fluctuating exotics prices and possibly wrong prices. We propose a simple and natural method to overcome these problems, illustrate drawbacks of the usual approach and show advantages of our method. To this end, we calibrate the Heston model to a time series of DAX implied volatility surfaces and then price cliquet options.

Keywords: calibration; data design; implied volatility surface; Heston model; cliquet option (search for similar items in EconPapers)
JEL-codes: C80 G13 (search for similar items in EconPapers)
Date: 2006
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