2022
DOI: 10.48550/arxiv.2205.10865
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Sparse modeling approach to the arbitrage-free interpolation of plain-vanilla option prices and implied volatilities

Abstract: We present a method for the arbitrage-free interpolation of plain-vanilla option prices and implied volatilities, which is based on a system of integral equations that relates terminal density and option prices. Using a discretization of the terminal density, we write these integral equations as a system of linear equations. We show that the kernel matrix of this system is in general ill-conditioned, so that it can not be solved for the discretized density using a naive approach. Instead, we construct a sparse… Show more

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