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Strong existence and uniqueness of a calibrated local stochastic volatility model

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  • Scander Mustapha

Abstract

We study a two-dimensional McKean-Vlasov stochastic differential equation, whose volatility coefficient depends on the conditional distribution of the second component with respect to the first component. We prove the strong existence and uniqueness of the solution, establishing the well-posedness of a two-factor local stochastic volatility (LSV) model calibrated to the market prices of European call options. In the spirit of [Jourdain and Zhou, 2020, Existence of a calibrated regime switching local volatility model.], we assume that the factor driving the volatility of the log-price takes finitely many values. Additionally, the propagation of chaos of the particle system is established, giving theoretical justification for the algorithm [Julien Guyon and Henry-Labord\`ere, 2012, Being particular about calibration.].

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  • Scander Mustapha, 2024. "Strong existence and uniqueness of a calibrated local stochastic volatility model," Papers 2406.14074, arXiv.org.
    • Handle: RePEc:arx:papers:2406.14074
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    References listed on IDEAS

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    1. Kohatsu-Higa Arturo & Ogawa Shigeyoshi, 1997. "Weak rate of convergence for an Euler scheme of nonlinear SDE’s," Monte Carlo Methods and Applications, De Gruyter, vol. 3(4), pages 327-346, December.
    2. Benjamin Jourdain & Alexandre Zhou, 2020. "Existence of a calibrated regime switching local volatility model," Mathematical Finance, Wiley Blackwell, vol. 30(2), pages 501-546, April.
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