Heat kernel methods in finance: the SABR model

Details Heat kernel methods in finance: the SABR model Heat kernel methods in finance: the SABR model

2012-01-06

arxiv.org/abs/1201.1437v2

Economy

Quantitative Finance

Pricing of Securities

59 pages, no figures

Scientific paper

The SABR model is a stochastic volatility model not admitting a closed form solution. Hagan, Kumar, Leniewski and Woodward have obtained an approximate solution by means of perturbative techniques. A more precise approximation was found by Henry-Labord\`ere with the heat kernel expansion method. The latter relies on deep and hard theorems from Riemannian geometry which are almost totally unknown to the professionals of finance, who however are those primarily interested in these results. The goal of this report is to fill this gap and to make these topics understandable with a basic knowledge of calculus and linear algebra.

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