Numerix Support Papers

Alexander Antonov, PhD

Michael Konikov, PhD

Generalized Carr-Pelts Volatility SVP,

Head of Quantitative
Development
Surface mkonikov@numerix.com

January 2018
Michael Spector, PhD
Director of Quantitative
Research
mspector@numerix.com

We provide a simple derivation and a concrete implementation of a volatility surface Numerix LLC
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parametrization proposed by Carr and Pelts in [2], as well as a way to generalize
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it to a parametrization that can be fitted to an arbitrarily rich set of options data. 5th Floor
New York, NY 10016
We also address handling discrete dividends in the context of this volatility surface.
Tel +1 212 302 2220
Numerical results are included.

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Numerix LLC. All rights reserved. Numerix,
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either registered trademarks, or
trademarks, of Numerix LLC in the United
States and/or other countries.
Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

1 Introduction
Parametric volatility surfaces are used in financial modeling to trade vanilla options and as
an input in more complicated models for exotics such as the Local Volatility (LV) model. A
particularly important use of such surfaces is in Dupire’s formulation of the LV model, where the
parametrization is used to obtain the derivatives of the implied volatilities that enter Dupire’s
formula. The local volatility itself is usually not available analytically, but implied volatility
usually is. To produce a sensible local volatility function using Dupire’s formula, the volatility
surface should not only be free of any arbitrage but should also be sufficiently smooth. Typically,
it is very difficult to guarantee the total absence of arbitrage working directly in the implied
volatility space since arbitrage conditions are difficult to translate into volatility terms. On the
other hand, though we can ensure that our surface is arbitrage free if we parametrize it in the
price space, it is difficult to also achieve a nice shape for the implied volatility surface in that
space.
The methodology described by Carr and Pelts (see [2]) is unique in that it simultaneously
guarantees no arbitrage and provides a reasonable shape for the implied volatility surface.
Moreover, we show that both the implied and local volatilities are known essentially in closed
form. We provide a simplified explanation of how such a surface can be implemented in practice
in Section 2. We also include a generalization allowing for an arbitrarily flexible surface to fit a
very rich set of options data in Section 3. In Section 4, we show how to incorporate discrete
dividends in the construction of the volatility surface. In Section 5, we include numerical results.

2 Formulation
Following the approach in [2], we parametrize the implied volatility surface as follows:

C(K, T ) = D(T ) (F (T )∆+ − K∆− ) , (2.1)

∆+ = Ω(z+ ), (2.2)
∆− = Ω(z− ), (2.3)
z+ = z− + τ (T ), (2.4)
∫ z
Ω(z) = e−h(s) ds, (2.5)
−∞
F (T )
log = h(z+ ) − h(z− ), (2.6)
K

where τ is increasing for all t and h is convex for all z. Here, K is the strike price, C(K, T ) is the
European call option price, D(T ) is the domestic discount factor, and F (T ) is the forward price.

1. Given T and K, we find τ and solve (2.6) for z− , which is related by τ to z+ via (2.4).

2. From z+ and z− , we compute ∆+ and ∆− using (2.2) and (2.3), respectively.

3. Finally, we obtain the arbitrage-free price using (2.1).

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

In particular, for the Black-Scholes (BS) model, we have:

√
τ (T ) = σ T ,
Ω(z) = Φ(z),
z2 1
h(z) = + log(2π).
2 2

We would like our surface to be an extension of the BS surface with piecewise-constant volatility.
In particular, this will help with calibration, where we can use the BS model calibrated to ATM
options as a smart initial guess (SIG). For a set of maturities Ti with T0 = 0, we parametrize τ (t)
with positive volatility-like quantities σi , such that for t ∈ [Ti , Ti+1 ],
v
u i−1
u∑
τ (t) = t σ 2 (Tj+1 − Tj ) + σ 2 (t − Ti ).
j i
j=0

This is precisely the standard deviation of a BS model, so initially the σi values will simply be
stripped from ATM options as BS forward volatilities. We parametrize h as a piecewise-quadratic
differentiable convex function; if h is convex, differentiable, and infinite in the tails, then (2.6)
always has a unique solution. To see this, suppose that we have two solutions with a convex and
differentiable h with infinite tails. Then, by the mean value theorem, there can be two points
with equal slope. That implies that, if h is not a linear function, its derivative must increase
in some region and decrease elsewhere. Therefore, its second derivative must change sign,
contradicting the assumed convexity of h.
For implementation, we use a grid zj , j = 0, . . . , 2N with z0 = −∞, zN = 0, and z2N = ∞, as
well as values γj > 0, α, and β, and define h ∈ C 1 (R) as:

(z − z[j] )2
h(z) = αj + βj (z − z[j] ) +
2γj

for z ∈ [zj , zj+1 ], where

[j] ≡ j × 1j≥N + (j + 1) × 1j<N ,

and

αN = αN −1 = α, (2.7)
βN = βN −1 = β. (2.8)

Imposing continuity and differentiability, we find the following recursive expressions for αj+1
and βj+1 for j > N :

(zj+1 − zj )2
αj+1 = αj + βj (zj+1 − zj ) + ,
2γj
zj+1 − zj
βj+1 = βj + ,
γj

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

and the following expressions for j < N :

(zj − zj+1 )2
αj−1 = αj + βj (zj − zj+1 ) + ,
2γj
zj − zj+1
βj−1 = βj + .
γj

For calibration, we initially set γj = 1 for all j, α = 0, and β = 0. We then recursively compute αj ,
βj , and then compute Ωj = Ω(zj ) starting with Ω0 = 0 and using:
( )
∫ zj+1 (z−z[j] )2 ∫ zj+1 −z[j] ( )
− αj +βj (z−z[j] )+ z2
− βj z+ 2γ
2γj −αj
Ωj+1 = Ωj + e dz = Ωj + e e j dz
zj zj −z[j]
[ ( ) ( )]
√ zj+1 − z[j] √ zj − z[j] √
2πγj e 2 γj βj −αj Φ
1 2
= Ωj + √ + γj β j − Φ √ + γj βj .
γj γj

Next, we set
α = log Ω2N

and adjust all the αj by α, and all the Ωj by e−α , so that Ω2N = 1. It is easy to see that Ω defined
by: [ ( ) ( )]
√ z − z[j] √ zj − z[j] √
2πγj e 2 γj βj −αj Φ
1 2
Ω(z) = Ωj + √ + γ β
j j − Φ √ + γ β
j j
γj γj
for z ∈ [zj , zj+1 ] is a proper cumulative distribution function. Now, in order to solve

X = h(z− + τ ) − h(z− ) (2.9)

for z− , where X = log F K

(T )
, we need to determine the intervals to which z− and z− + τ belong.
We use the following simple algorithm:

1. For j = 1, . . . , 2N , assume z ∈ [zj−1 , zj ].

2. For k = minn {zn > zj−1 + τ }, . . . , minn {zn > zj + τ }, assume z + τ ∈ [zk−1 , zk ].

3. Solve the quadratic equation X = h(z + τ ) − h(z).

4. If there is a root z− with z− ∈ [zj−1 , zj ] and z− + τ ∈ [zk−1 , zk ], then stop. (Otherwise, continue
looping.)

Next, we compute the local volatility analytically for this parametrization. This makes the
parametrization useful for an arbitrage-free parametric implied volatility surface. It can also
be used as the first step in calibrating an LV model and possibly even for calibrating a Local
Stochastic Volatility (LSV) model using Gyöngy’s lemma (for rapid calibration). We recall the
Dupire formula:

∂T C + µT K∂K C + qT C
σ 2 (T, K) = 1 2 2 , (2.10)
2 K ∂K C

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

where µt is the stock price drift and qt is the continuous dividend yield. We then compute:

∂K C = ∂K [D(T ) (F (T )∆+ − K∆− )]

= D(T ) (F (T )∂K ∆+ − ∆− − K∂K ∆− )
= D(T ) (F (T )Ω′ (z+ )∂K z+ − ∆− − KΩ′ (z− )∂K z− )
(( ) )
1 ′ ′
= D(T ) − [F (T )Ω (z+ ) − KΩ (z− )] ∂X z− − ∆−
K
([ ] )
= D(T ) Ω′ (z− ) − eX Ω′ (z+ ) ∂X z− − ∆−
= −D(T )∆− , (2.11)

where the equality in (2.11) comes from (2.9). We differentiate again to get:

2 D(T ) ′ D(T )e−h(z− )

∂K C= Ω (z− )∂X z− = , (2.12)
K K (h′ (z+ ) − h′ (z− ))

where we obtain ∂X z− by differentiating (2.9) with respect to X:

1 = [h′ (z− + τ ) − h′ (z− )]∂X z− = [h′ (z+ ) − h′ (z− )]∂X z− .

Finally, the last piece needed to compute local volatility using the Dupire formula is:

∂T C = ∂T [D(T ) (F (T )∆+ − K∆− )]

= D(T ) (rT KΩ(z− ) − qT F (T )Ω(z+ ) + F (T )Ω′ (z+ )∂T z+ − KΩ′ (z− )∂T z− )
( )
= D(T ) rT KΩ(z− ) − qT F (T )Ω(z+ ) + F (T )e−h(z+ ) τ ′ (T ) . (2.13)

Plugging in (2.11), (2.12), and (2.13) into (2.10), we obtain the following formula for the LV
coefficient:

rT KΩ(z− ) − qT F (T )Ω(z+ ) + F (T )e−h(z+ ) τ ′ (T )

σ 2 (T, K) =
Ke−h(z− )
2(h′ (z+ )−h′ (z− ))
−µT KΩ(z− ) + qT F (T )Ω(z+ ) − qT KΩ(z− )
+
Ke−h(z− )
2(h′ (z+ )−h′ (z− ))

= 2τ ′ (T ) (h′ (z+ ) − h′ (z− ))

σ 2 (T ) (h′ (z+ ) − h′ (z− ))
=
τ (T )
σ 2 (T )
= . (2.14)
τ (T )∂X z |z=z−

For the BS case with h′ (z) = z, the denominator is simply τ (T ) and the local volatility becomes
the BS volatility, as expected. We can also see that in order for the surface to be arbitrage free,
it is necessary and sufficient that τ be a positive non-decreasing function and h be a convex
positive function.

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

3 Generalization
In this section, we generalize the surface introduced in Section 2. Note that although the surface
is fairly flexible, it essentially corresponds to the separable local volatility structure:

2
σLV (T, K)T = C 2 (K)τ (T ),

which is incapable of fitting an arbitrary local volatility. We can make the surface more flexible
if we take ∆+ and ∆− to be a weighted combination of Ωj , with positive weights summing to
one. This results in:

C(K, T ) = D(T ) (F (T )∆+ − K∆− ) , (3.1)

∑
∆+ = wj Ωj (z+j ), (3.2)
j
∑
∆− = wj Ωj (z−j ), (3.3)
j

z+j = z−j + τj (T ), (3.4)

∫
Ωj (z) = e−hj (z) dz, (3.5)

F (T )
log = hj (z+j ) − hj (z−j ), (3.6)
K

and the following formula for the local volatility:

∑
2
F (T ) j wj e−hj (z+j ) τj′ (T )
σ (T, K) = ∑ −hj (z−j )
K j wj 2 h′ (ze )−h′ (z )
( j +j j −j )
∑ σ 2 (T )
F (T ) j wj e−hj (z+j ) τjj (T )
= ∑ −hj (z−j ) (3.7)
K j wj h′ (ze )−h′ (z )
( j +j j −j )
∑ 2
−hj (z−j ) σj (T )
j wj e τj (T )
=∑ .
e−hj (z−j )
j wj (h′ (z+j )−h′ (z−j ))
j j

To ensure the smoothness of the resulting surface in an overdetermined calibration setup,

smoothness penalties for internal parameters (γ and σ) as well as for the resulting local volatil-
ities are available.

4 Cash Dividends
We handle cash dividends using the spot adjustment method, decomposing the stock process
St into a pure dividend part and a martingale part (see [1] for a justification) as:
∑
St = S̃t + Dk P (t, τk ).
τk >t

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

Note that:
∑
S̃0 = S0 − Dk P (0, τk ),
τk >0

and that:
∑
St − K = S̃t + Dk P (t, τk ) − K = S̃t − K̃,
τk >t

where
∑
K̃ = K − Dk P (t, τk ),
τk >t

and
∫t
rs ds
S̃t = e 0 Xt

for some positive local martingale Xt . This means we can use the methodology in Sections 2–3,
as long as we adjust the spot and strike values.

5 Numerical Results
To demonstrate how our methodology works in practice, we took S0 = $100, r = 4%, q = 2%,
and the LV coefficients given in Table 1, where each curve is represented by two rows: the
x-coordinate and the y-coordinate. (The beginning of the time interval where the curve is
applicable is in the first column.) We priced the European options with an LV model using the
finite difference method and the surface from Table 1; for each maturity, we used seven strikes
log-uniformly distributed around the forward from −3 to +3 standard deviations computed with
σ = 20%. The option priced at each strike and maturity was the out-of-the money (OTM) option,
i.e., either a call or a put, depending on which option is out of the money.
Then, we fit the generalized Carr-Pelts volatility surface described in Section 3 to these
quotes. We used three weights, 17 z-points, and regularized calibration by adding smoothness
penalties to the least-squares objective function. The smoothness penalties are controlled by a
tension parameter, with higher values of the parameter corresponding to a smoother fit. The
following values were used for the tension in the smoothness penalties:

• 1 for σ,

• 0.01 for γ, and

• 0.01 for the resulting LV coefficient at strikes corresponding to the mid-interval z-points.

The results of the fit in terms of the implied volatility as well as a comparison of the analytically
computed local volatility to the numerically computed local volatility are shown in Tables 2 and
3, where the Numer LV column is the local volatility from the discretized version of the Dupire
formula (2.10), and the Analyt LV column is the local volatility from the Carr-Pelts surface. A
plot of the generalized Carr-Pelts local volatility surface is also shown in Figure 1.
Next, we used the fitted Carr-Pelts surface in the Dupire model with the same grid as the
original LV model and used it to price the same European options used in the Carr-Pelts surface
calibration. The results comparing the original prices and the ones obtained from the Dupire
model are shown in Tables 4 and 5. The maximum error relative to spot was about 3.7 basis

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

points (bps), and the average error was about 1.1 bps. The fitted surface parameters can be
found in Tables 6 and 7.
Table 1: LV surface

x -1.26 -1.03 -0.79 -0.59 -0.42 -0.28 -0.16 -0.05 0.05 0.14 0.23 0.30 0.38 0.56
0
y 76% 75% 73% 73% 72% 70% 64% 55% 47% 42% 38% 36% 35% 34%
x -1.26 -1.04 -0.79 -0.59 -0.42 -0.28 -0.16 -0.05 0.05 0.14 0.23 0.30 0.37 0.56
0.1
y 63% 65% 66% 67% 66% 63% 57% 49% 43% 39% 36% 34% 33% 31%
x -1.26 -1.04 -0.79 -0.59 -0.42 -0.28 -0.16 -0.05 0.05 0.14 0.23 0.30 0.37 0.56
0.2
y 64% 63% 63% 62% 60% 56% 51% 45% 41% 37% 35% 33% 32% 30%
x -1.26 -1.04 -0.79 -0.59 -0.43 -0.28 -0.16 -0.05 0.05 0.14 0.22 0.30 0.37 0.55
0.3
y 62% 61% 59% 58% 55% 51% 46% 42% 39% 36% 34% 32% 31% 29%
x -1.22 -1.00 -0.76 -0.57 -0.40 -0.27 -0.14 -0.03 0.06 0.15 0.24 0.31 0.38 0.56
0.4
y 59% 57% 55% 53% 49% 46% 42% 39% 36% 34% 33% 31% 30% 28%
x -1.22 -1.00 -0.76 -0.57 -0.41 -0.27 -0.14 -0.04 0.06 0.15 0.23 0.31 0.38 0.56
0.5
y 56% 54% 51% 48% 45% 42% 39% 37% 35% 33% 32% 31% 30% 28%
x -1.18 -0.96 -0.73 -0.54 -0.38 -0.25 -0.13 -0.02 0.08 0.16 0.24 0.32 0.39 0.57
0.6
y 53% 50% 47% 44% 41% 39% 37% 35% 33% 32% 31% 30% 30% 28%
x -1.18 -0.96 -0.73 -0.54 -0.39 -0.25 -0.13 -0.02 0.07 0.16 0.24 0.32 0.39 0.57
0.7
y 50% 47% 44% 41% 39% 37% 35% 34% 33% 31% 31% 30% 29% 28%
x -1.15 -0.92 -0.70 -0.52 -0.36 -0.23 -0.11 -0.01 0.09 0.17 0.25 0.33 0.40 0.58
0.8
y 46% 44% 41% 39% 37% 35% 34% 33% 32% 31% 30% 29% 29% 28%
x -1.15 -0.93 -0.70 -0.52 -0.37 -0.23 -0.11 -0.01 0.09 0.17 0.25 0.33 0.40 0.58
0.9
y 43% 41% 39% 37% 35% 34% 33% 32% 31% 30% 30% 29% 29% 28%
x -1.15 -0.93 -0.70 -0.52 -0.37 -0.23 -0.12 -0.01 0.09 0.17 0.25 0.33 0.40 0.58
1.0
y 42% 40% 38% 36% 34% 33% 32% 31% 31% 30% 29% 29% 29% 28%
x -1.15 -0.93 -0.70 -0.52 -0.37 -0.23 -0.12 -0.01 0.08 0.17 0.25 0.33 0.39 0.58
1.1
y 41% 39% 37% 35% 34% 33% 32% 31% 30% 30% 29% 29% 28% 28%

The first column indicates the beginning of the time interval over which the corresponding curve is applicable. Each curve is represented by
two rows: the x-coordinate and the y-coordinate. The x-coordinate is log (K/F ).

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

Table 2: Surface Fit for Maturities ≤ 1Y

Maturity Strike Input Price Surface Price Diff Numer LV Analyt LV Diff
0.2 76.47 1.60 1.62 1.73 57.6% 57.6% 0.0%
0.2 83.62 2.90 2.92 2.15 54.6% 54.6% 0.0%
0.2 91.44 5.06 5.05 -0.78 48.5% 48.5% 0.0%
0.2 100.00 8.90 8.91 1.00 42.1% 42.1% 0.0%
0.2 109.36 4.87 4.86 -1.73 31.6% 31.6% 0.0%
0.2 119.59 2.17 2.17 -0.23 34.5% 34.5% 0.0%
0.2 130.78 0.75 0.73 -1.82 33.2% 33.2% 0.0%
0.4 68.42 1.76 1.75 -1.12 53.5% 53.5% 0.0%
0.4 77.65 3.36 3.36 0.08 45.1% 45.3% 0.2%
0.4 88.12 6.19 6.16 -2.86 43.7% 43.7% 0.0%
0.4 100.00 11.77 11.77 -0.41 37.0% 37.0% 0.0%
0.4 113.48 6.21 6.22 0.85 29.9% 29.9% 0.0%
0.4 128.79 2.56 2.58 1.92 29.5% 29.6% 0.0%
0.4 146.15 0.78 0.78 0.29 26.0% 26.0% 0.0%
0.6 62.83 1.67 1.67 -0.73 49.7% 49.7% 0.0%
0.6 73.36 3.41 3.41 0.00 39.3% 39.3% 0.0%
0.6 85.65 6.66 6.64 -1.17 40.0% 40.0% 0.0%
0.6 100.00 13.65 13.65 -0.01 34.3% 34.3% 0.0%
0.6 116.76 7.03 7.04 1.42 29.0% 29.0% 0.0%
0.6 136.32 2.77 2.78 0.73 27.6% 27.6% 0.0%
0.6 159.16 0.78 0.78 0.28 23.8% 23.8% 0.0%
0.8 58.47 1.53 1.53 -0.25 45.9% 45.9% 0.0%
0.8 69.92 3.31 3.30 -0.94 32.0% 32.0% 0.0%
0.8 83.62 6.85 6.85 -0.19 37.6% 37.6% 0.0%
0.8 100.00 15.07 15.07 0.01 32.8% 32.8% 0.0%
0.8 119.59 7.63 7.64 1.12 30.1% 30.1% 0.0%
0.8 143.01 2.91 2.91 -0.03 28.7% 28.7% 0.0%
0.8 171.03 0.78 0.78 0.27 23.8% 23.8% 0.0%
1.0 54.88 1.38 1.38 0.17 41.9% 41.9% 0.0%
1.0 67.03 3.17 3.16 -0.81 31.8% 31.8% 0.0%
1.0 81.87 6.93 6.93 0.36 36.2% 36.2% 0.0%
1.0 100.00 16.23 16.23 -0.20 32.3% 32.3% 0.0%
1.0 122.14 8.11 8.12 0.34 32.4% 32.4% 0.0%
1.0 149.18 3.03 3.02 -0.56 29.3% 29.3% 0.0%
1.0 182.21 0.78 0.78 -0.06 23.8% 23.8% 0.0%

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

Table 3: Surface Fit for Maturities > 1Y

Maturity Strike Input Price Surface Price Diff Numer LV Analyt LV Diff
1.2 51.83 1.26 1.26 0.32 38.5% 38.5% 0.0%
1.2 64.52 3.04 3.03 -0.37 32.7% 32.7% 0.0%
1.2 80.33 6.96 6.97 0.64 36.1% 36.1% 0.0%
1.2 100.00 17.25 17.25 -0.12 32.4% 32.4% 0.0%
1.2 124.49 8.54 8.54 -0.26 33.6% 33.6% 0.0%
1.2 154.99 3.14 3.13 -0.58 29.6% 29.6% 0.0%
1.2 192.95 0.79 0.79 -0.28 24.9% 24.9% 0.0%
1.4 49.17 1.16 1.17 0.41 38.5% 38.5% 0.0%
1.4 62.30 2.93 2.93 -0.01 33.3% 33.3% 0.0%
1.4 78.93 6.99 7.00 0.71 36.1% 36.1% 0.0%
1.4 100.00 18.20 18.20 0.04 32.4% 32.4% 0.0%
1.4 126.70 8.95 8.95 -0.65 34.2% 34.2% 0.0%
1.4 160.53 3.24 3.24 -0.26 29.7% 29.7% 0.0%
1.4 203.38 0.81 0.80 -0.26 26.0% 26.0% 0.0%
1.6 46.82 1.09 1.10 0.38 39.7% 39.7% 0.0%
1.6 60.29 2.86 2.86 0.08 33.9% 33.9% 0.0%
1.6 77.65 7.03 7.04 0.53 36.1% 36.1% 0.0%
1.6 100.00 19.10 19.10 0.22 32.3% 32.3% 0.0%
1.6 128.79 9.35 9.35 -0.80 34.4% 34.4% 0.0%
1.6 165.86 3.36 3.36 0.34 29.6% 29.6% 0.0%
1.6 213.60 0.83 0.83 -0.06 26.6% 26.6% 0.0%
1.8 44.71 1.04 1.04 0.31 40.4% 40.4% 0.0%
1.8 58.47 2.80 2.80 0.20 34.4% 34.3% 0.0%
1.8 76.47 7.08 7.08 0.38 35.9% 35.9% 0.0%
1.8 100.00 19.95 19.95 0.42 32.2% 32.2% 0.0%
1.8 130.78 9.74 9.74 -0.94 34.4% 34.4% 0.0%
1.8 171.03 3.47 3.48 0.65 29.5% 29.5% 0.0%
1.8 223.67 0.85 0.85 0.04 26.9% 26.9% 0.0%
2.0 42.80 1.00 0.99 -0.09 41.3% 41.3% 0.0%
2.0 56.80 2.75 2.75 -0.07 34.7% 34.7% 0.0%
2.0 75.36 7.12 7.12 -0.03 35.6% 35.6% 0.0%
2.0 100.00 20.75 20.76 0.55 32.1% 32.1% 0.0%
2.0 132.69 10.12 10.11 -1.13 34.3% 34.3% 0.0%
2.0 176.07 3.59 3.60 0.70 29.5% 29.5% 0.0%
2.0 233.62 0.87 0.87 0.03 27.2% 27.2% 0.0%

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

Table 4: Option Repricing with the Dupire Model for Maturities ≤ 1Y

Maturity Strike Input Price Model Price Diff (bps)

0.2 76.47 1.602 1.619 2
0.2 83.62 2.902 2.933 3
0.2 91.44 5.056 5.069 1
0.2 100.00 8.902 8.939 4
0.2 109.36 4.874 4.874 0
0.2 119.59 2.172 2.149 2
0.2 130.78 0.748 0.726 2
0.4 68.42 1.757 1.743 1
0.4 77.65 3.363 3.377 1
0.4 88.12 6.189 6.174 2
0.4 100.00 11.774 11.766 1
0.4 113.48 6.210 6.215 0
0.4 128.79 2.565 2.582 2
0.4 146.15 0.777 0.783 1
0.6 62.83 1.674 1.664 1
0.6 73.36 3.408 3.405 0
0.6 85.65 6.655 6.645 1
0.6 100.00 13.648 13.662 1
0.6 116.76 7.028 7.058 3
0.6 136.32 2.771 2.780 1
0.6 159.16 0.777 0.784 1
0.8 58.47 1.531 1.524 1
0.8 69.92 3.312 3.304 1
0.8 83.62 6.852 6.856 0
0.8 100.00 15.066 15.073 1
0.8 119.59 7.627 7.632 1
0.8 143.01 2.914 2.916 0
0.8 171.03 0.776 0.784 1
1.0 54.88 1.383 1.381 0
1.0 67.03 3.172 3.164 1
1.0 81.87 6.928 6.936 1
1.0 100.00 16.232 16.239 1
1.0 122.14 8.113 8.119 1
1.0 149.18 3.029 3.026 0
1.0 182.21 0.781 0.786 0

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

Table 5: Option Repricing with the Dupire Model for Maturities > 1Y

Maturity Strike Input Price Model Price Diff (bps)

1.2 51.83 1.257 1.257 0
1.2 64.52 3.038 3.035 0
1.2 80.33 6.959 6.969 1
1.2 100.00 17.254 17.259 1
1.2 124.49 8.542 8.552 1
1.2 154.99 3.136 3.130 1
1.2 192.95 0.791 0.794 0
1.4 49.17 1.163 1.165 0
1.4 62.30 2.935 2.937 0
1.4 78.93 6.992 7.004 1
1.4 100.00 18.203 18.206 0
1.4 126.70 8.954 8.938 2
1.4 160.53 3.245 3.243 0
1.4 203.38 0.807 0.810 0
1.6 46.82 1.092 1.095 0
1.6 60.29 2.857 2.862 0
1.6 77.65 7.033 7.042 1
1.6 100.00 19.099 19.101 0
1.6 128.79 9.355 9.342 1
1.6 165.86 3.358 3.360 0
1.6 213.60 0.827 0.832 1
1.8 44.71 1.038 1.040 0
1.8 58.47 2.797 2.800 0
1.8 76.47 7.078 7.084 1
1.8 100.00 19.947 19.953 1
1.8 130.78 9.745 9.740 0
1.8 171.03 3.473 3.478 1
1.8 223.67 0.849 0.855 1
2.0 42.80 0.996 0.994 0
2.0 56.80 2.750 2.751 0
2.0 75.36 7.123 7.125 0
2.0 100.00 20.753 20.761 1
2.0 132.69 10.124 10.110 1
2.0 176.07 3.589 3.595 1
2.0 233.62 0.874 0.880 1

Table 6: Fitted σ Parameters

weight/date 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8

0.36 59% 51% 46% 43% 40% 38% 37% 37% 37% 37%
0.33 47% 40% 31% 22% 18% 17% 18% 20% 21% 22%
0.31 39% 32% 33% 36% 38% 39% 39% 39% 38% 37%

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

Table 7: Fitted α, β, and γ Parameters

Params α β γ
zmid /weight 0.36 0.33 0.31 0.36 0.33 0.31 0.36 0.33 0.31
-3.43 4.58 4.18 4.66 -2.33 -1.45 -2.18 1.27 7.52 1.69
-2.79 3.66 3.58 3.78 -1.95 -1.34 -1.90 1.11 3.67 1.55
-2.36 2.91 3.04 3.02 -1.56 -1.18 -1.65 1.11 2.80 1.69
-1.93 2.30 2.56 2.38 -1.30 -1.04 -1.36 1.62 2.95 1.50
-1.50 1.77 2.14 1.84 -1.15 -0.94 -1.16 2.97 4.42 2.11
-1.07 1.31 1.76 1.40 -1.01 -0.82 -0.87 3.02 3.67 1.46
-0.64 0.94 1.47 1.21 -0.71 -0.53 -0.04 1.40 1.45 0.52
-0.21 0.73 1.27 1.23 -0.29 -0.42 0.14 1.04 3.94 2.40
0.21 0.73 1.27 1.23 -0.29 -0.42 0.14 0.36 5.25 4.25
0.64 0.86 1.11 1.31 0.91 -0.34 0.24 0.52 2.40 3.90
1.07 1.43 1.00 1.44 1.73 -0.16 0.35 0.87 0.37 2.58
1.50 2.28 1.18 1.63 2.23 0.99 0.52 3.28 1.30 2.30
1.93 3.26 1.68 1.89 2.36 1.32 0.70 2.92 0.71 3.48
2.36 4.30 2.37 2.22 2.51 1.93 0.83 2.88 1.85 3.11
2.79 5.41 3.25 2.60 2.65 2.16 0.97 3.46 2.34 3.70
3.43 6.57 4.21 3.04 2.78 2.34 1.08 2.99 2.74 9.72

60 %

50 %

40 %

30 % 2.0
1.8
1.6
1.4
1.2
−3 1.0 ity
ur
−2
−1 0.8 t
0 0.6 a
Strike ( 1 0.4 M
in std. d 2
evs from 3 0.2
the forw
ard)

Figure 1: Carr-Pelts local volatility surface.

6 Conclusion
We provided a simple description of the volatility surface parametrization introduced by Carr
and Pelts [2] along with a practical recipe for an efficent implementation. A simple and elegant
formula for the local volatility was derived. Inspired by this formula, we were able to generalize
the parametrization to achieve an arbitrary level of flexibility in calibrating to a rich set of options

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Generalized Carr-Pelts Volatility Surface | January 2018 Numerix Support Papers

data. We demonstrated how our methodology works in practice with numerical results. The
forms of both the implied and local volatilities are known in closed form. The richness of the
proposed structure together with the use of smoothness penalties allows for a close fit to option
prices as well as resulting in a smooth local volatility surface. When we used our surface as an
input to the Dupire LV model with the finite difference method, we obtained values that were
very close to the European option prices used as inputs for surface calibration. We were also
able to incorporate discrete dividends into our framework.

References
[1] Buehler, H. Volatility and Dividends II: Consistent Cash Dividends. Available at https:
//papers.ssrn.com/sol3/papers.cfm?abstract_id=2639318, May 2017.

[2] Carr, P., and Pelts, G. Duality, Deltas, and Derivatives Pricing, June 2015.

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