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RFS Advance Access published online on June 30, 2006
Review of Financial Studies, doi:10.1093/rfs/hhl013
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

Approximation and Calibration of Short-Term Implied Volatilities Under Jump-Diffusion Stochastic Volatility

Alexey Medvedev 1 and Olivier Scaillet 1 *
1 HEC Genève and Swiss Finance Institute, Université de Genève

* To whom correspondence should be addressed.
Olivier Scaillet, E-mail: scaillet{at}hec.unige.ch


  Abstract

We derive an asymptotic expansion formula for option implied volatility under a two-factor jump-diffusion stochastic volatility model when time-to-maturity is small. We further propose a simple calibration procedure of an arbitrary parametric model to short-term near-the-money implied volatilities. An important advantage of our approximation is that it is free of the unobserved spot volatility. Therefore, the model can be calibrated on option data pooled across different calendar dates in order to extract information from the dynamics of the implied volatility smile. An example of calibration to a sample of S&P500 option prices is provided.


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