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Calibration of the Volatility in Option Pricing Using the Total Variation Regularization

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  • Yu-Hua Zeng
  • Shou-Lei Wang
  • Yu-Fei Yang

Abstract

In market transactions, volatility, which is a very important risk measurement in financial economics, has significantly intimate connection with the future risk of the underlying assets. Identifying the implied volatility is a typical PDE inverse problem. In this paper, based on the total variation regularization strategy, a bivariate total variation regularization model is proposed to estimate the implied volatility. We not only prove the existence of the solution, but also provide the necessary condition of the optimal control problem—Euler‐Lagrange equation. The stability and convergence analyses for the proposed approach are also given. Finally, numerical experiments have been carried out to show the effectiveness of the method.

Suggested Citation

  • Yu-Hua Zeng & Shou-Lei Wang & Yu-Fei Yang, 2014. "Calibration of the Volatility in Option Pricing Using the Total Variation Regularization," Journal of Applied Mathematics, John Wiley & Sons, vol. 2014(1).
    • Handle: RePEc:wly:jnljam:v:2014:y:2014:i:1:n:510819
    DOI: 10.1155/2014/510819
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