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Asymptotic Implied Volatility at the Second Order with Application to the SABR Model

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  • Louis Paulot

Abstract

We provide a general method to compute a Taylor expansion in time of implied volatility for stochastic volatility models, using a heat kernel expansion. Beyond the order 0 implied volatility which is already known, we compute the first order correction exactly at all strikes from the scalar coefficient of the heat kernel expansion. Furthermore, the first correction in the heat kernel expansion gives the second order correction for implied volatility, which we also give exactly at all strikes. As an application, we compute this asymptotic expansion at order 2 for the SABR model.

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  • Louis Paulot, 2009. "Asymptotic Implied Volatility at the Second Order with Application to the SABR Model," Papers 0906.0658, arXiv.org, revised May 2016.
    • Handle: RePEc:arx:papers:0906.0658
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    References listed on IDEAS

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    1. H. Berestycki & J. Busca & I. Florent, 2002. "Asymptotics and calibration of local volatility models," Quantitative Finance, Taylor & Francis Journals, vol. 2(1), pages 61-69.
    2. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
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