2023/05/23 by Fabien Le Floc’h, Floc'h, Fabien Le · 1 citation
Economics, Econometrics and Finance · Mathematics · #Stochastic processes and financial applications #Monetary Policy and Economic Impact #Mathematical Approximation and Integration
paper · pdf · doi:10.48550/arxiv.2305.13791
This paper generalizes the local variance gamma model of Carr and Nadtochiy, to a piecewise quadratic local variance function. The formulation encompasses the piecewise linear Bachelier and piecewise linear Black local variance gamma models. The quadratic local variance function results in an arbitrage-free interpolation of class C3. The increased smoothness over the piecewise-constant and piecewise-linear representation allows to reduce the number of knots when interpolating raw market quotes, thus providing an interesting alternative to regularization while reducing the computational cost.