A General Asymptotic Implied Volatility for Stochastic Volatility Models

Details A General Asymptotic Implied Volatility for Stochastic Volatility Models A General Asymptotic Implied Volatility for Stochastic Volatility Models

2005-04-13

arxiv.org/abs/cond-mat/0504317v2

Physics

Condensed Matter

Other Condensed Matter

35 pp. References added. Some typos corrected

Scientific paper

In this paper, we derive a general asymptotic implied volatility at the first-order for any stochastic volatility model using the heat kernel expansion on a Riemann manifold endowed with an Abelian connection. This formula is particularly useful for the calibration procedure. As an application, we obtain an asymptotic smile for a SABR model with a mean-reversion term, called lambda-SABR, corresponding in our geometric framework to the Poincar\'{e} hyperbolic plane. When the lambda-SABR model degenerates into the SABR-model, we show that our asymptotic implied volatility is a better approximation than the classical Hagan-al expression . Furthermore, in order to show the strength of this geometric framework, we give an exact solution of the SABR model with beta=0 or 1. In a next paper, we will show how our method can be applied in other contexts such as the derivation of an asymptotic implied volatility for a Libor market model with a stochastic volatility.

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