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Lo, Chia Chun and Skindilias, Konstantinos (2011) Local Volatility Calibration with the Markov Chain Approximation. Centre for EMEA Banking, Finance and Economics Working Paper Series, 2011 (29). pp. 1-11.
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CentreforEMEABankingFinanceAndEconomicsWorkingPaperSeries No.29 11.pdf - Published Version Download (385kB) | Preview |
Abstract / Description
We propose a method for calibrating the local volatility surface that relaxes the computational complexity associated with many models and prices options consistently with the volatility skew. We achieve this under a continuous time semi-closed form solution based on the Markov chain approximation of Kushner (1990). The continuous time Markov chain setting can accommodate a diffusion or a jump-diffusion. We show that under both cases without the use of any regularisation we can accurately price out-of-sample options.
| Item Type: | Article |
|---|---|
| Uncontrolled Keywords: | Centre for EMEA Banking, Finance and Economics Working Paper Series, Local Volatility, Inverse Problem, Markov chain approximation, Spline estimation |
| Subjects: | 300 Social sciences > 330 Economics |
| Department: | Guildhall School of Business and Law |
| Depositing User: | David Pester |
| Date Deposited: | 22 Apr 2015 08:06 |
| Last Modified: | 22 Apr 2015 08:06 |
| URI: | https://repository.londonmet.ac.uk/id/eprint/466 |
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