Please use this identifier to cite or link to this item: http://scholarbank.nus.edu.sg/handle/10635/118602
Title: Calibration of Stochastic Volatility Models: A Tikhonov Regularization Approach
Authors: TANG LING
Keywords: stochastic volatility model, asset pricing, calibration, inverse problem, Tikhonov regularization method
Issue Date: 25-Jul-2014
Citation: TANG LING (2014-07-25). Calibration of Stochastic Volatility Models: A Tikhonov Regularization Approach. ScholarBank@NUS Repository.
Abstract: We aim to calibrate stochastic volatility models from option prices. We develop a Tikhonov regularization approach to recover the risk ne-utral drift term and diffusion term of the volatility (or variance) process which are presumed to be a deterministic function of instantaneous volatility (or v-ariance) and time, as well as the correlation coefficient as a function of time. In contrast to the most existing literature, we do not assume that these terms in the general stochastic volatility model have special structures. A modified Dupire's equation associated with stochastic volatility models is first proposed, which allows us to formulate the calibration problem as a standard inverse problem of partial differential equations. Then a Tikhonov regularization method can be used to recover these three terms respectively. The necessary condition that the optimal solution satisfies is derived for each term. We further simplified these necessary conditions. Then we propose a gradient descent algorithm to numerically find the optimal solution. Our algorithm can be applied to calibrate general stochastic volatility models. The numerical test and market test are presented to demonstrate the efficiency of our numerical algorithm.
URI: http://scholarbank.nus.edu.sg/handle/10635/118602
Appears in Collections:Ph.D Theses (Open)

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