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A new look at short-term implied volatility in asset price models with jumps
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Mijatović, Aleksandar and Tankov, Peter (2016) A new look at short-term implied volatility in asset price models with jumps. Mathematical Finance, 26 (1). pp. 149-183. doi:10.1111/mafi.12055 ISSN 0960-1627.
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Official URL: http://dx.doi.org/10.1111/mafi.12055
Abstract
We analyze the behavior of the implied volatility smile for options close to expiry in the exponential Lévy class of asset price models with jumps. We introduce a new renormalization of the strike variable with the property that the implied volatility converges to a nonconstant limiting shape, which is a function of both the diffusion component of the process and the jump activity (Blumenthal–Getoor) index of the jump component. Our limiting implied volatility formula relates the jump activity of the underlying asset price process to the short‐end of the implied volatility surface and sheds new light on the difference between finite and infinite variation jumps from the viewpoint of option prices: in the latter, the wings of the limiting smile are determined by the jump activity indices of the positive and negative jumps, whereas in the former, the wings have a constant model‐independent slope. This result gives a theoretical justification for the preference of the infinite variation Lévy models over the finite variation ones in the calibration based on short‐maturity option prices.
Item Type: | Journal Article | ||||||
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Divisions: | Faculty of Science, Engineering and Medicine > Science > Mathematics | ||||||
Journal or Publication Title: | Mathematical Finance | ||||||
Publisher: | Wiley-Blackwell Publishing, Inc. | ||||||
ISSN: | 0960-1627 | ||||||
Official Date: | January 2016 | ||||||
Dates: |
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Volume: | 26 | ||||||
Number: | 1 | ||||||
Page Range: | pp. 149-183 | ||||||
DOI: | 10.1111/mafi.12055 | ||||||
Status: | Peer Reviewed | ||||||
Publication Status: | Published | ||||||
Access rights to Published version: | Restricted or Subscription Access |
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