Pricing with Passion: The Local Occupied Volatility (LOV) Model

TL;DR

The paper presents the LOV model, a new volatility model that balances local and path-dependent features, ensuring calibration to vanilla options and capturing stylized volatility facts.

Contribution

Introduces the LOV model, a novel approach that combines local and path-dependent volatility dynamics with automatic calibration capabilities.

Findings

Successfully calibrates to European vanilla options.

Captures stylized facts of volatility.

Validates through American-European options calibration.

Abstract

We introduce the Local Occupied Volatility (LOV) model that sits between Dupire's local volatility and fully path-dependent dynamics. By design, the LOV model ensures automatic calibration to European vanilla options, while offering the flexibility to capture stylized facts of volatility or fit additional instruments. This is achieved by tuning the occupation sensitivity function that quantifies the effect of path-dependent shocks on volatility. We validate the model through the joint American-European calibration of options chain on non-dividend paying stocks.