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Tangent Models As A Mathematical Framework For Dynamic Calibration

Author

Listed:
  • RENÉ CARMONA

    (Bendheim Center for Finance, ORFE, Princeton University, Princeton, NJ 08544, USA)

  • SERGEY NADTOCHIY

    (Bendheim Center for Finance, ORFE, Princeton University, Princeton, NJ 08544, USA)

Abstract

Motivated by the desire to integrate repeated calibration procedures into a single dynamic market model, we introduce the notion of a "tangent model" in an abstract set up, and we show that this new mathematical paradigm accommodates all the recent attempts to study consistency and absence of arbitrage in market models. For the sake of illustration, we concentrate on the case when market quotes provide the prices of European call options for a specific set of strikes and maturities. While reviewing our recent results on dynamic local volatility and tangent Lévy models, we present a theory of tangent models unifying these two approaches and construct a new class of tangent Lévy models, which allows the underlying to have both continuous and pure jump components.

Suggested Citation

  • René Carmona & Sergey Nadtochiy, 2011. "Tangent Models As A Mathematical Framework For Dynamic Calibration," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 14(01), pages 107-135.
    • Handle: RePEc:wsi:ijtafx:v:14:y:2011:i:01:n:s0219024911006280
    DOI: 10.1142/S0219024911006280
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    References listed on IDEAS

    as
    1. Michael Roper, 2008. "Implied volatility explosions: European calls and implied volatilities close to expiry in exponential L\'evy models," Papers 0809.3305, arXiv.org, revised Sep 2008.
    2. Martin Schweizer & Johannes Wissel, 2008. "Arbitrage-free market models for option prices: the multi-strike case," Finance and Stochastics, Springer, vol. 12(4), pages 469-505, October.
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    Citations

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    Cited by:

    1. Sergey Nadtochiy & Jan Obloj, 2016. "Robust Trading of Implied Skew," Papers 1611.05518, arXiv.org.
    2. Sebastian Herrmann & Johannes Muhle-Karbe, 2017. "Model uncertainty, recalibration, and the emergence of delta–vega hedging," Finance and Stochastics, Springer, vol. 21(4), pages 873-930, October.
    3. Jan Kallsen & Paul Kruhner, 2013. "On a Heath-Jarrow-Morton approach for stock options," Papers 1305.5621, arXiv.org, revised Aug 2013.
    4. Rene Carmona & Yi Ma & Sergey Nadtochiy, 2015. "Simulation of Implied Volatility Surfaces via Tangent Levy Models," Papers 1504.00334, arXiv.org.
    5. Sergey Nadtochiy & Jan Obłój, 2017. "Robust Trading Of Implied Skew," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(02), pages 1-41, March.
    6. Jan Kallsen & Paul Krühner, 2015. "On a Heath–Jarrow–Morton approach for stock options," Finance and Stochastics, Springer, vol. 19(3), pages 583-615, July.

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