Arbitrage-free smoothing of the implied volatility surface

@inproceedings{Fengler2009ArbitragefreeSO,
  title={Arbitrage-free smoothing of the implied volatility surface},
  author={Matthias R. Fengler},
  year={2009}
}
The pricing accuracy and pricing performance of local volatility models depends on the absence of arbitrage in the implied volatility surface. An input implied volatility surface that is not arbitrage-free can result in negative transition probabilities and consequently mispricings and false greeks. We propose an approach for smoothing the implied volatility smile in an arbitrage-free way. The method is simple to implement, computationally cheap and builds on the well-founded theory of natural… CONTINUE READING

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