A General Asymptotic Implied Volatility for Stochastic Volatility Models

Pierre Henry-Labordere (1)

1 BARCAP - Barclays Capital

In this paper, we derive a general asymptotic implied volatility at the first-order for any stochastic volatility model using the heat kernel expansion on a Riemann manifold endowed with an Abelian connection. This formula is particularly useful for the calibration procedure. As an application, we obtain an asymptotic smile for a SABR model with a mean-reversion term, called lambda-SABR, corresponding in our geometric framework to the Poincaré hyperbolic plane. When the lambda-SABR model degenerates into the SABR-model, we show that our asymptotic implied volatility is a better approximation than the classical Hagan-al expression . Furthermore, in order to show the strength of this geometric framework, we give an exact solution of the SABR model with beta=0 or 1. In a next paper, we will show how our method can be applied in other contexts such as the derivation of an asymptotic implied volatility for a Libor market model with a stochastic volatility.

Mots clés: Heat kernel expansion; Hyperbolic geometry; Asymptotic smile formula; SABR model with mean-reversion term

Domaines: Autre [cond-mat.other]

Pierre Henry-Labordere. A General Asymptotic Implied Volatility for Stochastic Volatility Models. 2005. ⟨hal-00004632v2⟩