Moving Least Squares for Arbitrage-Free Price and Volatility Surfaces
To price exotic options consistently to market data, it is necessary to approximate the implied volatility surface (IVS) over the strike–maturity plane. To avoid mis-pricing and arbitrage strategies, the approximation must be arbitrage free. Based on the moving least squares (MLS) reconstruction, a numerical approach is presented in this paper to compute arbitrage-free surfaces which approximate observed market data.
KeywordsLocal Constraint Move Little Square Polynomial Space Local Volatility Traded Option
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