Risk glossary

 

Local volatility

Local volatility is a model used in derivative pricing to describe how the underlying asset’s volatility varies with both its current price and with time. While it can be fit to a smile at a particular time, the model is static and therefore does not capture volatility dynamics over time. It was introduced in 1994 by Bruno Dupire in his Risk paper ‘Pricing with a smile’. Its purpose was to explain the skew in volatility values with respect to underlying asset price. Typically, the implied volatility increases as the price diverges from the strike leading to a characteristic smile shape – hence its name ‘volatility smile’. This smile is not necessarily symmetrical about the strike but will be more symmetrical for symmetric products like those in foreign exchange.

Click here for articles on local volatility.

  • LinkedIn  
  • Save this article
  • Print this page  

You need to sign in to use this feature. If you don’t have a Risk.net account, please register for a trial.

Sign in
You are currently on corporate access.

To use this feature you will need an individual account. If you have one already please sign in.

Sign in.

Alternatively you can request an indvidual account here: