Calibration of local stochastic volatility models to market smiles

Pierre Henry-Labordère introduces a new technique for calibrating local volatility extensions of arbitrary multi-factor stochastic volatility models to market smiles. Although approximate, this technique is both fast and accurate. The procedure is illustrated with the Bergomi variance curve model

The development of exotic options depending on the dynamics of implied volatilities calls for multi-factor stochastic volatility models (SVMs) such as the Bergomi variance curve model and the two-factor lognormal SVM. The former, based on the direct modelling of the joint dynamics of the spot and the implied variance swap volatilities, allows both a perfect fit to the Vix market and an easy Monte Carlo simulation.

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Calibration of

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