Please use this identifier to cite or link to this item: http://hdl.handle.net/10397/21075
Title: No-arbitrage interpolation of the option price function and its reformulation
Authors: Wang, Y
Yin, H
Qi, L 
Keywords: Interpolation
No-arbitrage principle
Option price functions
Semismooth equations
Superlinear convergence
Issue Date: 2004
Publisher: Springer
Source: Journal of optimization theory and applications, 2004, v. 120, no. 3, p. 627-649 How to cite?
Journal: Journal of optimization theory and applications 
Abstract: Several risk management and exotic option pricing models have been proposed in the literature which may price European options correctly. A prerequisite of these models is the interpolation of the market implied volatilities or the European option price function. However, the no-arbitrage principle places shape restrictions on the option price function. In this paper, an interpolation method is developed to preserve the shape of the option price function. The interpolation is optimal in terms of minimizing the distance between the implied risk-neutral density and the prior approximation function in L 2-norm, which is important when only a few observations are available. We reformulate the problem into a system of semismooth equations so that it can be solved efficiently.
URI: http://hdl.handle.net/10397/21075
ISSN: 0022-3239
EISSN: 1573-2878
DOI: 10.1023/B:JOTA.0000025713.44548.71
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