Cutting Edge introduction: Continuity error
Some quants discarded the continuous time model when it got in the way of arbitrage-free pricing – but others see a chance to fix the traditional ideal. Laurie Carver introduces this month’s technical section
Opinion was divided when Jesper Andreasen and Brian Huge – quants at Danske Bank in Copenhagen – unveiled a radical way to generate implied volatilities in two 2011 articles (Risk March 2011, pages 76–79, and Risk July 2011, pages 66–71). On the one hand, the new method promised arbitrage-free prices, but it did so by abandoning the continuous time model that is traditionally seen as the ideal.
An
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