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finmath lib is a Mathematical Finance Library in Java.
It provides algorithms and methodologies related to mathematical finance.
/*
* Created on 23.01.2004.
*
* (c) Copyright Christian P. Fries, Germany. Contact: [email protected].
*/
package net.finmath.functions;
import java.util.Calendar;
import net.finmath.rootfinder.NewtonsMethod;
import net.finmath.stochastic.RandomVariable;
import net.finmath.stochastic.Scalar;
/**
* This class implements some functions as static class methods.
*
* It provides functions like
*
* - the Black-Scholes formula,
*
- the inverse of the Back-Scholes formula with respect to (implied) volatility,
*
- the Bachelier formula,
*
- the inverse of the Bachelier formula with respect to (implied) volatility,
*
- the corresponding functions (versions) for caplets and swaptions,
*
- analytic approximation for European options under the SABR model,
*
- some convexity adjustments.
*
*
* @author Christian Fries
* @version 1.10
* @date 27.04.2012
*/
public class AnalyticFormulas {
/**
* Preventing instantiation of this class.
*/
private AnalyticFormulas() {
// This constructor will never be invoked
}
/**
* Calculates the Black-Scholes option value of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a log-normal process with constant log-volatility.
*
* The method also handles cases where the forward and/or option strike is negative
* and some limit cases where the forward and/or the option strike is zero.
*
* @param forward The forward of the underlying.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @param payoffUnit The payoff unit (e.g., the discount factor)
* @return Returns the value of a European call option under the Black-Scholes model.
*/
public static double blackScholesGeneralizedOptionValue(
final double forward,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double payoffUnit)
{
if(optionMaturity < 0) {
return 0;
}
else if(forward < 0) {
// We use max(X,0) = X + max(-X,0)
return (forward - optionStrike) * payoffUnit + blackScholesGeneralizedOptionValue(-forward, volatility, optionMaturity, -optionStrike, payoffUnit);
}
else if((forward == 0) || (optionStrike <= 0.0) || (volatility <= 0.0) || (optionMaturity <= 0.0))
{
// Limit case (where dPlus = +/- infty)
return Math.max(forward - optionStrike,0) * payoffUnit;
}
else
{
// Calculate analytic value
final double dPlus = (Math.log(forward / optionStrike) + 0.5 * volatility * volatility * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double dMinus = dPlus - volatility * Math.sqrt(optionMaturity);
final double valueAnalytic = (forward * NormalDistribution.cumulativeDistribution(dPlus) - optionStrike * NormalDistribution.cumulativeDistribution(dMinus)) * payoffUnit;
return valueAnalytic;
}
}
/**
* Calculates the Black-Scholes option value of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a log-normal process with constant log-volatility.
*
* The model specific quantities are considered to be random variable, i.e.,
* the function may calculate an per-path valuation in a single call.
*
* @param forward The forward of the underlying.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @param payoffUnit The payoff unit (e.g., the discount factor)
* @return Returns the value of a European call option under the Black-Scholes model.
*/
public static RandomVariable blackScholesGeneralizedOptionValue(
final RandomVariable forward,
final RandomVariable volatility,
final double optionMaturity,
final double optionStrike,
final RandomVariable payoffUnit)
{
if(optionMaturity < 0) {
return forward.mult(0.0);
}
else
{
final RandomVariable dPlus = forward.div(optionStrike).log().add(volatility.squared().mult(0.5 * optionMaturity)).div(volatility).div(Math.sqrt(optionMaturity));
final RandomVariable dMinus = dPlus.sub(volatility.mult(Math.sqrt(optionMaturity)));
final RandomVariable valueAnalytic = dPlus.apply(NormalDistribution::cumulativeDistribution).mult(forward).sub(dMinus.apply(NormalDistribution::cumulativeDistribution).mult(optionStrike)).mult(payoffUnit);
return valueAnalytic;
}
}
/**
* Calculates the Black-Scholes option value of a call, i.e., the payoff max(S(T)-K,0), where S follows a log-normal process with constant log-volatility.
*
* @param initialStockValue The spot value of the underlying.
* @param riskFreeRate The risk free rate r (df = exp(-r T)).
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @return Returns the value of a European call option under the Black-Scholes model.
*/
public static double blackScholesOptionValue(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
return blackScholesGeneralizedOptionValue(
initialStockValue * Math.exp(riskFreeRate * optionMaturity), // forward
volatility,
optionMaturity,
optionStrike,
Math.exp(-riskFreeRate * optionMaturity) // payoff unit
);
}
/**
* Calculates the Black-Scholes option value of a call, i.e., the payoff max(S(T)-K,0), where S follows a log-normal process with constant log-volatility.
*
* @param initialStockValue The spot value of the underlying.
* @param riskFreeRate The risk free rate r (df = exp(-r T)).
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @return Returns the value of a European call option under the Black-Scholes model.
*/
public static RandomVariable blackScholesOptionValue(
final RandomVariable initialStockValue,
final RandomVariable riskFreeRate,
final RandomVariable volatility,
final double optionMaturity,
final double optionStrike)
{
return blackScholesGeneralizedOptionValue(
initialStockValue.mult(riskFreeRate.mult(optionMaturity).exp()), // forward
volatility,
optionMaturity - 0.0,
optionStrike,
riskFreeRate.mult(-optionMaturity).exp() // payoff unit
);
}
/**
* Calculates the Black-Scholes option value of a call, i.e., the payoff max(S(T)-K,0), where S follows a log-normal process with constant log-volatility.
*
* @param initialStockValue The spot value of the underlying.
* @param riskFreeRate The risk free rate r (df = exp(-r T)).
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @return Returns the value of a European call option under the Black-Scholes model.
*/
public static RandomVariable blackScholesOptionValue(
final RandomVariable initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
return blackScholesGeneralizedOptionValue(
initialStockValue.mult(Math.exp(riskFreeRate*optionMaturity)), // forward
new Scalar(volatility),
optionMaturity - 0.0,
optionStrike,
new Scalar(Math.exp(-riskFreeRate*optionMaturity)) // payoff unit
);
}
/**
* Calculates the Black-Scholes option value of a call, i.e., the payoff max(S(T)-K,0), or a put, i.e., the payoff max(K-S(T),0), where S follows a log-normal process with constant log-volatility.
*
* @param initialStockValue The spot value of the underlying.
* @param riskFreeRate The risk free rate r (df = exp(-r T)).
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T for the call and zero for the put.
* @param isCall If true, the value of a call is calculated, if false, the value of a put is calculated.
* @return Returns the value of a European call/put option under the Black-Scholes model.
*/
public static double blackScholesOptionValue(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike,
final boolean isCall) {
final double callValue = blackScholesOptionValue(initialStockValue, riskFreeRate, volatility, optionMaturity, optionStrike);
if(isCall) {
return callValue;
}
else {
final double putValue = callValue - (initialStockValue-optionStrike * Math.exp(-riskFreeRate * optionMaturity));
return putValue;
}
}
/**
* Calculates the Black-Scholes option value of an atm call option.
*
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param forward The forward, i.e., the expectation of the index under the measure associated with payoff unit.
* @param payoffUnit The payoff unit, i.e., the discount factor or the anuity associated with the payoff.
* @return Returns the value of a European at-the-money call option under the Black-Scholes model
*/
public static double blackScholesATMOptionValue(
final double volatility,
final double optionMaturity,
final double forward,
final double payoffUnit)
{
if(optionMaturity < 0) {
return 0.0;
}
// Calculate analytic value
final double dPlus = 0.5 * volatility * Math.sqrt(optionMaturity);
final double dMinus = -dPlus;
final double valueAnalytic = (NormalDistribution.cumulativeDistribution(dPlus) - NormalDistribution.cumulativeDistribution(dMinus)) * forward * payoffUnit;
return valueAnalytic;
}
/**
* Calculates the delta of a call option under a Black-Scholes model
*
* The method also handles cases where the forward and/or option strike is negative
* and some limit cases where the forward or the option strike is zero.
* In the case forward = option strike = 0 the method returns 1.0.
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The delta of the option
*/
public static double blackScholesOptionDelta(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionMaturity < 0) {
return 0;
}
else if(initialStockValue < 0) {
// We use Indicator(S>K) = 1 - Indicator(-S>-K)
return 1 - blackScholesOptionDelta(-initialStockValue, riskFreeRate, volatility, optionMaturity, -optionStrike);
}
else if(initialStockValue == 0)
{
// Limit case (where dPlus = +/- infty)
if(optionStrike < 0) {
return 1.0; // dPlus = +infinity
} else if(optionStrike > 0) {
return 0.0; // dPlus = -infinity
}
else {
return 1.0; // Matter of definition of continuity of the payoff function
}
}
else if((optionStrike <= 0.0) || (volatility <= 0.0) || (optionMaturity <= 0.0)) // (and initialStockValue > 0)
{
// The Black-Scholes model does not consider it being an option
return 1.0;
}
else
{
// Calculate delta
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double delta = NormalDistribution.cumulativeDistribution(dPlus);
return delta;
}
}
/**
* Calculates the delta of a call option under a Black-Scholes model
*
* The method also handles cases where the forward and/or option strike is negative
* and some limit cases where the forward or the option strike is zero.
* In the case forward = option strike = 0 the method returns 1.0.
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The delta of the option
*/
public static RandomVariable blackScholesOptionDelta(
final RandomVariable initialStockValue,
final RandomVariable riskFreeRate,
final RandomVariable volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionMaturity < 0) {
return initialStockValue.mult(0.0);
}
else
{
// Calculate delta
final RandomVariable dPlus = initialStockValue.div(optionStrike).log().add(volatility.squared().mult(0.5).add(riskFreeRate).mult(optionMaturity)).div(volatility).div(Math.sqrt(optionMaturity));
final RandomVariable delta = dPlus.apply(NormalDistribution::cumulativeDistribution);
return delta;
}
}
/**
* Calculates the delta of a call option under a Black-Scholes model
*
* The method also handles cases where the forward and/or option strike is negative
* and some limit cases where the forward or the option strike is zero.
* In the case forward = option strike = 0 the method returns 1.0.
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The delta of the option
*/
public static RandomVariable blackScholesOptionDelta(
final RandomVariable initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
return blackScholesOptionDelta(initialStockValue, new Scalar(riskFreeRate), new Scalar(volatility), optionMaturity, optionStrike);
}
/**
* Calculates the delta of a call option under a Black-Scholes model
*
* The method also handles cases where the forward and/or option strike is negative
* and some limit cases where the forward or the option strike is zero.
* In the case forward = option strike = 0 the method returns 1.0.
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The delta of the option
*/
public static RandomVariable blackScholesOptionDelta(
final RandomVariable initialStockValue,
final RandomVariable riskFreeRate,
final RandomVariable volatility,
final double optionMaturity,
final RandomVariable optionStrike)
{
if(optionMaturity < 0) {
return initialStockValue.mult(0.0);
}
else
{
// Calculate delta
final RandomVariable dPlus = initialStockValue.div(optionStrike).log().add(volatility.squared().mult(0.5).add(riskFreeRate).mult(optionMaturity)).div(volatility).div(Math.sqrt(optionMaturity));
final RandomVariable delta = dPlus.apply(NormalDistribution::cumulativeDistribution);
return delta;
}
}
/**
* This static method calculated the gamma of a call option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The gamma of the option
*/
public static double blackScholesOptionGamma(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate gamma
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double gamma = Math.exp(-0.5*dPlus*dPlus) / (Math.sqrt(2.0 * Math.PI * optionMaturity) * initialStockValue * volatility);
return gamma;
}
}
/**
* This static method calculated the gamma of a call option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The gamma of the option
*/
public static RandomVariable blackScholesOptionGamma(
final RandomVariable initialStockValue,
final RandomVariable riskFreeRate,
final RandomVariable volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return initialStockValue.mult(0.0);
}
else
{
// Calculate gamma
final RandomVariable dPlus = initialStockValue.div(optionStrike).log().add(volatility.squared().mult(0.5).add(riskFreeRate).mult(optionMaturity)).div(volatility).div(Math.sqrt(optionMaturity));
final RandomVariable gamma = dPlus.squared().mult(-0.5).exp().div(initialStockValue.mult(volatility).mult(Math.sqrt(2.0 * Math.PI * optionMaturity)));
return gamma;
}
}
/**
* This static method calculated the gamma of a call option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The gamma of the option
*/
public static RandomVariable blackScholesOptionGamma(
final RandomVariable initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
return blackScholesOptionGamma(initialStockValue, new Scalar(riskFreeRate), new Scalar(volatility), optionMaturity, optionStrike);
}
/**
* Calculates the vega of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a
* normal process with constant volatility, i.e., a Black-Scholes model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma S(t)\mathrm{d}W(t)
* \]
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The vega of the option
*/
public static double blackScholesOptionVega(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate vega
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double vega = Math.exp(-0.5*dPlus*dPlus) / Math.sqrt(2.0 * Math.PI) * initialStockValue * Math.sqrt(optionMaturity);
return vega;
}
}
/**
* Calculates the vega of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a
* normal process with constant volatility, i.e., a Black-Scholes model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma S(t)\mathrm{d}W(t)
* \]
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The vega of the option
*/
public static RandomVariable blackScholesOptionVega(
final RandomVariable initialStockValue,
final RandomVariable riskFreeRate,
final RandomVariable volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return initialStockValue.mult(0.0);
}
else
{
// Calculate vega
final RandomVariable dPlus = initialStockValue.div(optionStrike).log().add(volatility.squared().mult(0.5).add(riskFreeRate).mult(optionMaturity)).div(volatility).div(Math.sqrt(optionMaturity));
final RandomVariable vega = dPlus.squared().mult(-0.5).exp().div(Math.sqrt(2.0 * Math.PI * optionMaturity)).mult(initialStockValue).mult(volatility);
return vega;
}
}
/**
* Calculates the vega of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a
* normal process with constant volatility, i.e., a Black-Scholes model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma S(t)\mathrm{d}W(t)
* \]
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The vega of the option
*/
public static RandomVariable blackScholesOptionVega(
final RandomVariable initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
return blackScholesOptionVega(initialStockValue, new Scalar(riskFreeRate), new Scalar(volatility), optionMaturity, optionStrike);
}
/**
* This static method calculated the vega of a call option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The vega of the option
*/
public static double blackScholesOptionTheta(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate theta
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double dMinus = dPlus - volatility * Math.sqrt(optionMaturity);
final double theta = volatility * Math.exp(-0.5*dPlus*dPlus) / Math.sqrt(2.0 * Math.PI) / Math.sqrt(optionMaturity) / 2 * initialStockValue + riskFreeRate * optionStrike * Math.exp(-riskFreeRate * optionMaturity) * NormalDistribution.cumulativeDistribution(dMinus);
return theta;
}
}
/**
* This static method calculated the rho of a call option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The rho of the option
*/
public static double blackScholesOptionRho(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate rho
final double dMinus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate - 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double rho = optionStrike * optionMaturity * Math.exp(-riskFreeRate * optionMaturity) * NormalDistribution.cumulativeDistribution(dMinus);
return rho;
}
}
/**
* Calculates the Black-Scholes option implied volatility of a call, i.e., the payoff
* max(S(T)-K,0)
, where S follows a log-normal process with constant log-volatility.
* The admissible values for optionValue are between forward * payoffUnit - optionStrike (the inner value) and forward * payoffUnit.
*
* @param forward The forward of the underlying (which is equal to S(0) / payoffUnit, given the spot value S(0)).
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @param payoffUnit The payoff unit (e.g., the discount factor), (which is equal to exp(-maturity * r), given the interest rate r).
* @param optionValue The option value. The admissible values for optionValue are between forward * payoffUnit - optionStrike (the inner value) and forward * payoffUnit.
* @return Returns the implied volatility of a European call option under the Black-Scholes model.
*/
public static double blackScholesOptionImpliedVolatility(
final double forward,
final double optionMaturity,
final double optionStrike,
final double payoffUnit,
final double optionValue)
{
// Limit the maximum number of iterations, to ensure this calculation returns fast, e.g. in cases when there is no such thing as an implied vol
// TODO An exception should be thrown, when there is no implied volatility for the given value.
final int maxIterations = 500;
final double maxAccuracy = 1E-15;
if(optionStrike <= 0.0)
{
// Actually it is not an option
return 0.0;
}
else
{
// Calculate an lower and upper bound for the volatility
final double p = NormalDistribution.inverseCumulativeDistribution((optionValue/payoffUnit+optionStrike)/(forward+optionStrike)) / Math.sqrt(optionMaturity);
final double q = 2.0 * Math.abs(Math.log(forward/optionStrike)) / optionMaturity;
final double volatilityLowerBound = p + Math.sqrt(Math.max(p * p - q, 0.0));
final double volatilityUpperBound = p + Math.sqrt( p * p + q );
// If strike is close to forward the two bounds are close to the analytic solution
if(Math.abs(volatilityLowerBound - volatilityUpperBound) < maxAccuracy) {
return (volatilityLowerBound+volatilityUpperBound) / 2.0;
}
// Solve for implied volatility
final NewtonsMethod solver = new NewtonsMethod(0.5*(volatilityLowerBound+volatilityUpperBound) /* guess */);
while(solver.getAccuracy() > maxAccuracy && !solver.isDone() && solver.getNumberOfIterations() < maxIterations) {
final double volatility = solver.getNextPoint();
// Calculate analytic value
final double dPlus = (Math.log(forward / optionStrike) + 0.5 * volatility * volatility * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double dMinus = dPlus - volatility * Math.sqrt(optionMaturity);
final double valueAnalytic = (forward * NormalDistribution.cumulativeDistribution(dPlus) - optionStrike * NormalDistribution.cumulativeDistribution(dMinus)) * payoffUnit;
final double derivativeAnalytic = forward * Math.sqrt(optionMaturity) * Math.exp(-0.5*dPlus*dPlus) / Math.sqrt(2.0*Math.PI) * payoffUnit;
final double error = valueAnalytic - optionValue;
solver.setValueAndDerivative(error,derivativeAnalytic);
}
return solver.getBestPoint();
}
}
/**
* Calculates the Black-Scholes option value of a digital call option.
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return Returns the value of a European call option under the Black-Scholes model
*/
public static double blackScholesDigitalOptionValue(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 1.0;
}
else
{
// Calculate analytic value
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double dMinus = dPlus - volatility * Math.sqrt(optionMaturity);
final double valueAnalytic = Math.exp(- riskFreeRate * optionMaturity) * NormalDistribution.cumulativeDistribution(dMinus);
return valueAnalytic;
}
}
/**
* Calculates the delta of a digital option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The delta of the digital option
*/
public static double blackScholesDigitalOptionDelta(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate delta
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double dMinus = dPlus - volatility * Math.sqrt(optionMaturity);
final double delta = Math.exp(-riskFreeRate * optionMaturity) * Math.exp(-0.5*dMinus*dMinus) / (Math.sqrt(2.0 * Math.PI * optionMaturity) * initialStockValue * volatility);
return delta;
}
}
/**
* Calculates the vega of a digital option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The vega of the digital option
*/
public static double blackScholesDigitalOptionVega(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate vega
final double dPlus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate + 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double dMinus = dPlus - volatility * Math.sqrt(optionMaturity);
final double vega = - Math.exp(-riskFreeRate * optionMaturity) * Math.exp(-0.5*dMinus*dMinus) / Math.sqrt(2.0 * Math.PI) * dPlus / volatility;
return vega;
}
}
/**
* Calculates the rho of a digital option under a Black-Scholes model
*
* @param initialStockValue The initial value of the underlying, i.e., the spot.
* @param riskFreeRate The risk free rate of the bank account numerarie.
* @param volatility The Black-Scholes volatility.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @return The rho of the digital option
*/
public static double blackScholesDigitalOptionRho(
final double initialStockValue,
final double riskFreeRate,
final double volatility,
final double optionMaturity,
final double optionStrike)
{
if(optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else if(optionStrike <= 0.0) {
final double rho = - optionMaturity * Math.exp(-riskFreeRate * optionMaturity);
return rho;
}
else
{
// Calculate rho
final double dMinus = (Math.log(initialStockValue / optionStrike) + (riskFreeRate - 0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double rho = - optionMaturity * Math.exp(-riskFreeRate * optionMaturity) * NormalDistribution.cumulativeDistribution(dMinus)
+ Math.sqrt(optionMaturity)/volatility * Math.exp(-riskFreeRate * optionMaturity) * Math.exp(-0.5*dMinus*dMinus) / Math.sqrt(2.0 * Math.PI);
return rho;
}
}
/**
* Calculate the value of a caplet assuming the Black'76 model.
*
* @param forward The forward (spot).
* @param volatility The Black'76 volatility.
* @param optionMaturity The option maturity
* @param optionStrike The option strike.
* @param periodLength The period length of the underlying forward rate.
* @param discountFactor The discount factor corresponding to the payment date (option maturity + period length).
* @return Returns the value of a caplet under the Black'76 model
*/
public static double blackModelCapletValue(
final double forward,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double periodLength,
final double discountFactor)
{
// May be interpreted as a special version of the Black-Scholes Formula
return AnalyticFormulas.blackScholesGeneralizedOptionValue(forward, volatility, optionMaturity, optionStrike, periodLength * discountFactor);
}
/**
* Calculate the implied volatility of a caplet assuming the Black'76 model.
*
* @param forward The forward (spot).
* @param optionMaturity The option maturity
* @param optionStrike The option strike.
* @param periodLength The period length of the underlying forward rate.
* @param discountFactor The discount factor corresponding to the payment date (option maturity + period length).
* @param value The value of the caplet.
* @return Returns the value of a caplet under the Black'76 model
*/
public static double blackModelCapletImpliedVolatility(
final double forward,
final double optionMaturity,
final double optionStrike,
final double periodLength,
final double discountFactor,
final double value)
{
// May be interpreted as a special version of the Black-Scholes Formula
return AnalyticFormulas.blackScholesOptionImpliedVolatility(forward, optionMaturity, optionStrike, periodLength * discountFactor, value);
}
/**
* Calculate the value of a digital caplet assuming the Black'76 model.
*
* @param forward The forward (spot).
* @param volatility The Black'76 volatility.
* @param periodLength The period length of the underlying forward rate.
* @param discountFactor The discount factor corresponding to the payment date (option maturity + period length).
* @param optionMaturity The option maturity
* @param optionStrike The option strike.
* @return Returns the price of a digital caplet under the Black'76 model
*/
public static double blackModelDigitalCapletValue(
final double forward,
final double volatility,
final double periodLength,
final double discountFactor,
final double optionMaturity,
final double optionStrike)
{
// May be interpreted as a special version of the Black-Scholes Formula
return AnalyticFormulas.blackScholesDigitalOptionValue(forward, 0.0, volatility, optionMaturity, optionStrike) * periodLength * discountFactor;
}
/**
* Calculate the delta of a digital caplet assuming the Black'76 model.
*
* @param forward The forward (spot).
* @param volatility The Black'76 volatility.
* @param periodLength The period length of the underlying forward rate.
* @param discountFactor The discount factor corresponding to the payment date (option maturity + period length).
* @param optionMaturity The option maturity
* @param optionStrike The option strike.
* @return Returns the price of a digital caplet under the Black'76 model
*/
public static double blackModelDigitalCapletDelta(
final double forward,
final double volatility,
final double periodLength,
final double discountFactor,
final double optionMaturity,
final double optionStrike)
{
// May be interpreted as a special version of the Black-Scholes Formula
return AnalyticFormulas.blackScholesDigitalOptionDelta(forward, 0.0, volatility, optionMaturity, optionStrike) * periodLength * discountFactor;
}
/**
* Calculate the value of a digital caplet assuming the Black'76 model.
*
* This method exists for backward compatibility due to a typo in an earlier version.
*
* @param forward The forward (spot).
* @param volatility The Black'76 volatility.
* @param periodLength The period length of the underlying forward rate.
* @param discountFactor The discount factor corresponding to the payment date (option maturity + period length).
* @param optionMaturity The option maturity
* @param optionStrike The option strike.
* @return Returns the price of a digital caplet under the Black'76 model
*/
public static double blackModelDgitialCapletValue(
final double forward,
final double volatility,
final double periodLength,
final double discountFactor,
final double optionMaturity,
final double optionStrike)
{
return AnalyticFormulas.blackModelDigitalCapletValue(forward, volatility, periodLength, discountFactor, optionMaturity, optionStrike);
}
/**
* Calculate the value of a swaption assuming the Black'76 model.
*
* @param forwardSwaprate The forward (spot)
* @param volatility The Black'76 volatility.
* @param optionMaturity The option maturity.
* @param optionStrike The option strike.
* @param swapAnnuity The swap annuity corresponding to the underlying swap.
* @return Returns the value of a Swaption under the Black'76 model
*/
public static double blackModelSwaptionValue(
final double forwardSwaprate,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double swapAnnuity)
{
// May be interpreted as a special version of the Black-Scholes Formula
return AnalyticFormulas.blackScholesGeneralizedOptionValue(forwardSwaprate, volatility, optionMaturity, optionStrike, swapAnnuity);
}
/**
* Calculates the value of an Exchange option under a generalized Black-Scholes model, i.e., the payoff \( max(S_{1}(T)-S_{2}(T),0) \),
* where \( S_{1} \) and \( S_{2} \) follow a log-normal process with constant log-volatility and constant instantaneous correlation.
*
* The method also handles cases where the forward and/or option strike is negative
* and some limit cases where the forward and/or the option strike is zero.
*
* @param spot1 Value of \( S_{1}(0) \)
* @param spot2 Value of \( S_{2}(0) \)
* @param volatility1 Volatility of \( \log(S_{1}(t)) \)
* @param volatility2 Volatility of \( \log(S_{2}(t)) \)
* @param correlation Instantaneous correlation of \( \log(S_{1}(t)) \) and \( \log(S_{2}(t)) \)
* @param optionMaturity The option maturity \( T \).
* @return Returns the value of a European exchange option under the Black-Scholes model.
*/
public static double margrabeExchangeOptionValue(
final double spot1,
final double spot2,
final double volatility1,
final double volatility2,
final double correlation,
final double optionMaturity)
{
final double volatility = Math.sqrt(volatility1*volatility1 + volatility2*volatility2 - 2.0 * volatility1*volatility2*correlation);
return blackScholesGeneralizedOptionValue(spot1, volatility, optionMaturity, spot2, 1.0);
}
/*
* Some functions for the Bachelier model. For more see BachelierModel class.
*/
/**
* Calculates the option value of a call, i.e., the payoff max(S(T)-K,0), where S follows a
* normal process with numeraire scaled volatility, i.e., a homogeneous Bachelier model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma exp(-r (T-t)) \mathrm{d}W(t)
* \]
*
* Considering the numeraire \( N(t) = exp(-r (T-t)) \), this implies that \( F(t) = S(t)/N(t) \) follows
* \[
* \mathrm{d} F(t) = \sigma \mathrm{d}W(t) \text{.}
* \]
*
* @param forward The forward of the underlying \( F(0) = S(0)/N(0) = S(0) \exp(r T) \).
* @param volatility The Bachelier volatility \( \sigma \) of the forward process.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike K.
* @param payoffUnit The payoff unit (e.g., the discount factor \( N(0)/N(T) = exp(-r T) \))
* @return Returns the value of a European call option under the Bachelier model.
*/
public static double bachelierOptionValue(
final double forward,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double payoffUnit)
{
return BachelierModel.bachelierOptionValue(forward, volatility, optionMaturity, optionStrike, payoffUnit);
}
/**
* Calculates the option value of a call, i.e., the payoff max(S(T)-K,0), where S follows a
* normal process with numeraire scaled volatility, i.e., a homogeneous Bachelier model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma exp(-r (T-t)) \mathrm{d}W(t)
* \]
* Considering the numeraire \( N(t) = exp(-r (T-t)) \), this implies that \( F(t) = S(t)/N(t) \) follows
* \[
* \mathrm{d} F(t) = \sigma \mathrm{d}W(t) \text{.}
* \]
*
* @param forward The forward of the underlying \( F(0) = S(0)/N(0) = S(0) \exp(r T) \).
* @param volatility The Bachelier volatility \( \sigma \) of the forward process.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike K.
* @param payoffUnit The payoff unit (e.g., the discount factor \( N(0)/N(T) = exp(-r T) \))
* @return Returns the value of a European call option under the Bachelier model.
*/
public static RandomVariable bachelierOptionValue(
final RandomVariable forward,
final RandomVariable volatility,
final double optionMaturity,
final double optionStrike,
final RandomVariable payoffUnit)
{
return BachelierModel.bachelierOptionValue(forward, volatility, optionMaturity, optionStrike, payoffUnit);
}
/**
* Calculates the Bachelier option implied volatility of a call, i.e., the payoff max(S(T)-K,0), where S follows a
* normal process with numeraire scaled volatility, i.e., a homogeneous Bachelier model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma exp(-r (T-t)) \mathrm{d}W(t)
* \]
* Considering the numeraire \( N(t) = exp(-r (T-t)) \), this implies that \( F(t) = S(t)/N(t) \) follows
* \[
* \mathrm{d} F(t) = \sigma \mathrm{d}W(t) \text{.}
* \]
*
* @param forward The forward of the underlying.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike. If the option strike is ≤ 0.0 the method returns the value of the forward contract paying S(T)-K in T.
* @param payoffUnit The payoff unit (e.g., the discount factor)
* @param optionValue The option value.
* @return Returns the implied volatility of a European call option under the Bachelier model.
*/
public static double bachelierOptionImpliedVolatility(
final double forward,
final double optionMaturity,
final double optionStrike,
final double payoffUnit,
final double optionValue)
{
return BachelierModel.bachelierOptionImpliedVolatility(forward, optionMaturity, optionStrike, payoffUnit, optionValue);
}
/**
* Calculates the option delta dV(0)/dS(0) of a call option, i.e., the payoff V(T)=max(S(T)-K,0), where S follows a
* normal process with numeraire scaled volatility, i.e., a homogeneous Bachelier model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma exp(-r (T-t)) \mathrm{d}W(t)
* \]
* Considering the numeraire \( N(t) = exp(-r (T-t)) \), this implies that \( F(t) = S(t)/N(t) \) follows
* \[
* \mathrm{d} F(t) = \sigma \mathrm{d}W(t) \text{.}
* \]
*
* @param forward The forward of the underlying \( F(0) = S(0)/N(0) = S(0) \exp(r T) \).
* @param volatility The Bachelier volatility \( \sigma \) of the forward process.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike K.
* @param payoffUnit The payoff unit (e.g., the discount factor \( N(0)/N(T) = exp(-r T) \))
* @return Returns the value of the option delta (dV/dS(0)) of a European call option under the Bachelier model.
*/
public static double bachelierOptionDelta(
final double forward,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double payoffUnit)
{
return BachelierModel.bachelierOptionDelta(forward, volatility, optionMaturity, optionStrike, payoffUnit);
}
/*
* CMS Options
*/
/**
* Calculate the value of a CMS option using the Black-Scholes model for the swap rate together with
* the Hunt-Kennedy convexity adjustment.
*
* @param forwardSwaprate The forward swap rate
* @param volatility Volatility of the log of the swap rate
* @param swapAnnuity The swap annuity
* @param optionMaturity The option maturity
* @param swapMaturity The swap maturity
* @param payoffUnit The payoff unit, e.g., the discount factor corresponding to the payment date
* @param optionStrike The option strike
* @return Value of the CMS option
*/
public static double huntKennedyCMSOptionValue(
final double forwardSwaprate,
final double volatility,
final double swapAnnuity,
final double optionMaturity,
final double swapMaturity,
final double payoffUnit,
final double optionStrike)
{
final double a = 1.0/swapMaturity;
final double b = (payoffUnit / swapAnnuity - a) / forwardSwaprate;
final double convexityAdjustment = Math.exp(volatility*volatility*optionMaturity);
final double valueUnadjusted = blackModelSwaptionValue(forwardSwaprate, volatility, optionMaturity, optionStrike, swapAnnuity);
final double valueAdjusted = blackModelSwaptionValue(forwardSwaprate * convexityAdjustment, volatility, optionMaturity, optionStrike, swapAnnuity);
return a * valueUnadjusted + b * forwardSwaprate * valueAdjusted;
}
/**
* Calculate the value of a CMS strike using the Black-Scholes model for the swap rate together with
* the Hunt-Kennedy convexity adjustment.
*
* @param forwardSwaprate The forward swap rate
* @param volatility Volatility of the log of the swap rate
* @param swapAnnuity The swap annuity
* @param optionMaturity The option maturity
* @param swapMaturity The swap maturity
* @param payoffUnit The payoff unit, e.g., the discount factor corresponding to the payment date
* @param optionStrike The option strike
* @return Value of the CMS strike
*/
public static double huntKennedyCMSFloorValue(
final double forwardSwaprate,
final double volatility,
final double swapAnnuity,
final double optionMaturity,
final double swapMaturity,
final double payoffUnit,
final double optionStrike)
{
final double huntKennedyCMSOptionValue = huntKennedyCMSOptionValue(forwardSwaprate, volatility, swapAnnuity, optionMaturity, swapMaturity, payoffUnit, optionStrike);
// A floor is an option plus the strike (max(X,K) = max(X-K,0) + K)
return huntKennedyCMSOptionValue + optionStrike * payoffUnit;
}
/**
* Calculate the adjusted forward swaprate corresponding to a change of payoff unit from the given swapAnnuity to the given payoffUnit
* using the Black-Scholes model for the swap rate together with the Hunt-Kennedy convexity adjustment.
*
* @param forwardSwaprate The forward swap rate
* @param volatility Volatility of the log of the swap rate
* @param swapAnnuity The swap annuity
* @param optionMaturity The option maturity
* @param swapMaturity The swap maturity
* @param payoffUnit The payoff unit, e.g., the discount factor corresponding to the payment date
* @return Convexity adjusted forward rate
*/
public static double huntKennedyCMSAdjustedRate(
final double forwardSwaprate,
final double volatility,
final double swapAnnuity,
final double optionMaturity,
final double swapMaturity,
final double payoffUnit)
{
final double a = 1.0/swapMaturity;
final double b = (payoffUnit / swapAnnuity - a) / forwardSwaprate;
final double convexityAdjustment = Math.exp(volatility*volatility*optionMaturity);
final double rateUnadjusted = forwardSwaprate;
final double rateAdjusted = forwardSwaprate * convexityAdjustment;
return (a * rateUnadjusted + b * forwardSwaprate * rateAdjusted) * swapAnnuity / payoffUnit;
}
/**
* Calculated the approximation to the lognormal Black volatility using the
* standard SABR model and the standard Hagan approximation.
*
* @param alpha initial value of the stochastic volatility process of the SABR model.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param underlying Underlying (spot) value.
* @param strike Strike.
* @param maturity Maturity.
* @return Implied lognormal Black volatility.
*/
public static double sabrHaganLognormalBlackVolatilityApproximation(final double alpha, final double beta, final double rho, final double nu, final double underlying, final double strike, final double maturity)
{
return sabrHaganLognormalBlackVolatilityApproximation(alpha, beta, rho, nu, 0.0, underlying, strike, maturity);
}
/**
* Calculated the approximation to the lognormal Black volatility using the
* standard SABR model and the standard Hagan approximation.
*
* @param alpha initial value of the stochastic volatility process of the SABR model.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param displacement The displacement parameter d.
* @param underlying Underlying (spot) value.
* @param strike Strike.
* @param maturity Maturity.
* @return Implied lognormal Black volatility.
*/
public static double sabrHaganLognormalBlackVolatilityApproximation(final double alpha, final double beta, final double rho, final double nu, final double displacement, double underlying, double strike, final double maturity)
{
if(alpha <= 0) {
throw new IllegalArgumentException("α must be greater than 0.");
}
if(rho > 1 || rho < -1) {
throw new IllegalArgumentException("ρ must be between -1 and 1.");
}
if(nu <= 0) {
throw new IllegalArgumentException("ν must be greater than 0.");
}
if(underlying <= 0) {
throw new IllegalArgumentException("Approximation not definied for non-positive underlyings.");
}
// Apply displacement. Displaced model is just a shift on underlying and strike.
underlying += displacement;
strike += displacement;
if(Math.abs(underlying - strike) < 0.0001 * (1+Math.abs(underlying))) {
/*
* ATM case - we assume underlying = strike
*/
final double term1 = alpha / (Math.pow(underlying,1-beta));
final double term2 = Math.pow(1-beta,2)/24 * Math.pow(alpha,2)/Math.pow(underlying,2*(1-beta))
+ rho*beta*alpha*nu/(4*Math.pow(underlying,1-beta))
+ (2-3*rho*rho)*nu*nu/24;
return term1 * (1+ term2 * maturity);
}
else{
/*
* General non-ATM case no prob with log(F/K)
*/
final double forwardTimesStrike = underlying * strike;
final double z = nu/alpha * Math.pow(forwardTimesStrike, (1-beta)/2) * Math.log(underlying / strike);
final double x = Math.log((Math.sqrt(1- 2*rho * z + z*z) + z - rho)/(1 - rho));
final double term1 = alpha / Math.pow(forwardTimesStrike,(1-beta)/2)
/ (1 + Math.pow(1-beta,2)/24*Math.pow(Math.log(underlying/strike),2)
+ Math.pow(1-beta,4)/1920 * Math.pow(Math.log(underlying/strike),4));
final double term2 = (Math.abs(x-z) < 1E-10) ? 1 : z / x;
final double term3 = 1 + (Math.pow(1 - beta,2)/24 *Math.pow(alpha, 2)/Math.pow(forwardTimesStrike, 1-beta)
+ rho*beta*nu*alpha / 4 / Math.pow(forwardTimesStrike, (1-beta)/2)
+ (2-3*rho*rho)/24 * nu*nu) *maturity;
return term1 * term2 * term3;
}
}
/**
* Return the implied normal volatility (Bachelier volatility) under a SABR model using the
* approximation of Berestycki.
*
* @param alpha initial value of the stochastic volatility process of the SABR model.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param displacement The displacement parameter d.
* @param underlying Underlying (spot) value.
* @param strike Strike.
* @param maturity Maturity.
* @return The implied normal volatility (Bachelier volatility)
*/
public static double sabrBerestyckiNormalVolatilityApproximation(final double alpha, final double beta, final double rho, final double nu, final double displacement, double underlying, double strike, final double maturity)
{
// Apply displacement. Displaced model is just a shift on underlying and strike.
underlying += displacement;
strike += displacement;
final double forwardStrikeAverage = (underlying+strike) / 2.0; // Original paper uses a geometric average here
double z;
if(beta < 1.0) {
z = nu / alpha * (Math.pow(underlying, 1.0-beta) - Math.pow(strike, 1.0-beta)) / (1.0-beta);
} else {
z = nu / alpha * Math.log(underlying/strike);
}
final double x = Math.log((Math.sqrt(1.0 - 2.0*rho*z + z*z) + z - rho) / (1.0-rho));
double term1;
if(Math.abs(underlying - strike) < 1E-10 * (1+Math.abs(underlying))) {
// ATM case - we assume underlying = strike
term1 = alpha * Math.pow(underlying, beta);
}
else if(x == 0) {
// x ~ z for z small
if(beta < 1.0) {
term1 = (underlying-strike) * alpha / (Math.pow(underlying, 1.0-beta) - Math.pow(strike, 1.0-beta)) / (1.0-beta);
} else {
term1 = (underlying-strike) * alpha / Math.log(underlying/strike);
}
}
else {
term1 = nu * (underlying-strike) / x;
}
final double sigma = term1 * (1.0 + maturity * ((-beta*(2-beta)*alpha*alpha)/(24*Math.pow(forwardStrikeAverage,2.0*(1.0-beta))) + beta*alpha*rho*nu / (4*Math.pow(forwardStrikeAverage,(1.0-beta))) + (2.0 -3.0*rho*rho)*nu*nu/24));
return Math.max(sigma, 0.0);
}
/**
* Return the implied normal volatility (Bachelier volatility) under a SABR model using the
* approximation of Hagan.
*
* @param alpha initial value of the stochastic volatility process of the SABR model.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param displacement The displacement parameter d.
* @param underlying Underlying (spot) value.
* @param strike Strike.
* @param maturity Maturity.
* @return The implied normal volatility (Bachelier volatility)
*/
public static double sabrNormalVolatilityApproximation(final double alpha, final double beta, final double rho, final double nu, final double displacement, double underlying, double strike, final double maturity)
{
// Apply displacement. Displaced model is just a shift on underlying and strike.
underlying += displacement;
strike += displacement;
final double forwardStrikeAverage = (underlying+strike) / 2.0;
final double z = nu / alpha * (underlying-strike) / Math.pow(forwardStrikeAverage, beta);
final double x = Math.log((Math.sqrt(1.0 - 2.0*rho*z + z*z) + z - rho) / (1.0-rho));
double term1;
if(Math.abs(underlying - strike) < 1E-8 * (1+Math.abs(underlying))) {
// ATM case - we assume underlying = strike
term1 = alpha * Math.pow(underlying, beta);
}
else {
final double z2 = (1.0 - beta) / (Math.pow(underlying, 1.0-beta) - Math.pow(strike, 1.0-beta));
term1 = alpha * z2 * z * (underlying-strike) / x;
}
final double sigma = term1 * (1.0 + maturity * ((-beta*(2-beta)*alpha*alpha)/(24*Math.pow(forwardStrikeAverage,2.0*(1.0-beta))) + beta*alpha*rho*nu / (4*Math.pow(forwardStrikeAverage,(1.0-beta))) + (2.0 -3.0*rho*rho)*nu*nu/24));
return Math.max(sigma, 0.0);
}
/**
* Return the parameter alpha (initial value of the stochastic vol process) of a SABR model using the
* to match the given at-the-money volatility.
*
* @param normalVolatility ATM volatility to match.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param displacement The displacement parameter d.
* @param underlying Underlying (spot) value.
* @param maturity Maturity.
* @return The implied normal volatility (Bachelier volatility)
*/
public static double sabrAlphaApproximation(final double normalVolatility, final double beta, final double rho, final double nu, final double displacement, double underlying, final double maturity)
{
// Apply displacement. Displaced model is just a shift on underlying and strike.
underlying += displacement;
// ATM case.
final double forwardStrikeAverage = underlying;
final double guess = normalVolatility/Math.pow(underlying, beta);
final NewtonsMethod search = new NewtonsMethod(guess);
while(!search.isDone() && search.getAccuracy() > 1E-16 && search.getNumberOfIterations() < 100) {
final double alpha = search.getNextPoint();
final double term1 = alpha * Math.pow(underlying, beta);
final double term2 = (1.0 + maturity * ((-beta*(2-beta)*alpha*alpha)/(24*Math.pow(forwardStrikeAverage,2.0*(1.0-beta))) + beta*alpha*rho*nu / (4*Math.pow(forwardStrikeAverage,(1.0-beta))) + (2.0 -3.0*rho*rho)*nu*nu/24));
final double derivativeTerm1 = Math.pow(underlying, beta);
final double derivativeTerm2 = maturity * (2*(-beta*(2-beta)*alpha)/(24*Math.pow(forwardStrikeAverage,2.0*(1.0-beta))) + beta*rho*nu / (4*Math.pow(forwardStrikeAverage,(1.0-beta))));
final double sigma = term1 * term2;
final double derivative = derivativeTerm1 * term2 + term1 * derivativeTerm2;
search.setValueAndDerivative(sigma-normalVolatility, derivative);
}
return search.getBestPoint();
}
/**
* Return the skew of the implied normal volatility (Bachelier volatility) under a SABR model using the
* approximation of Berestycki. The skew is the first derivative of the implied vol w.r.t. the strike,
* evaluated at the money.
*
* @param alpha initial value of the stochastic volatility process of the SABR model.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param displacement The displacement parameter d.
* @param underlying Underlying (spot) value.
* @param maturity Maturity.
* @return The skew of the implied normal volatility (Bachelier volatility)
*/
public static double sabrNormalVolatilitySkewApproximation(final double alpha, final double beta, final double rho, final double nu, final double displacement, double underlying, final double maturity)
{
final double sigma = sabrBerestyckiNormalVolatilityApproximation(alpha, beta, rho, nu, displacement, underlying, underlying, maturity);
// Apply displacement. Displaced model is just a shift on underlying and strike.
underlying += displacement;
final double a = alpha/Math.pow(underlying, 1-beta);
final double c = 1.0/24*Math.pow(a, 3)*beta*(1.0-beta);
final double skew = + (rho*nu/a + beta) * (1.0/2.0*sigma/underlying) - maturity*c*(3.0*rho*nu/a + beta - 2.0);
// Some alternative representations
// double term1dterm21 = (beta*(2-beta)*alpha*alpha*alpha)/24*Math.pow(underlying,-3.0*(1.0-beta)) * (1.0-beta);
// double term1dterm22 = beta*alpha*alpha*rho*nu / 4 * Math.pow(underlying,-2.0*(1.0-beta)) * -(1.0-beta) * 0.5;
// skew = + 1.0/2.0*sigma/underlying*(rho*nu/alpha * Math.pow(underlying, 1-beta) + beta) + maturity * (term1dterm21+term1dterm22);
// skew = + (rho*nu/a + beta) * (1.0/2.0*sigma/underlying - maturity*3.0*c) + maturity*2.0*c*(1+beta);
// skew = + (rho*nu/a + beta) * (1.0/2.0*sigma/underlying - maturity*c) - maturity*c*(2.0*rho*nu/a - 2.0);
// The follwoing may be used as approximations (for beta=0 the approximation is exact).
// double approximation = (rho*nu/a + beta) * (1.0/2.0*sigma/underlying);
// double residual = skew - approximation;
return skew;
}
/**
* Return the curvature of the implied normal volatility (Bachelier volatility) under a SABR model using the
* approximation of Berestycki. The curvatures is the second derivative of the implied vol w.r.t. the strike,
* evaluated at the money.
*
* @param alpha initial value of the stochastic volatility process of the SABR model.
* @param beta CEV parameter of the SABR model.
* @param rho Correlation (leverages) of the stochastic volatility.
* @param nu Volatility of the stochastic volatility (vol-of-vol).
* @param displacement The displacement parameter d.
* @param underlying Underlying (spot) value.
* @param maturity Maturity.
* @return The curvature of the implied normal volatility (Bachelier volatility)
*/
public static double sabrNormalVolatilityCurvatureApproximation(final double alpha, final double beta, final double rho, final double nu, final double displacement, double underlying, final double maturity)
{
final double sigma = sabrBerestyckiNormalVolatilityApproximation(alpha, beta, rho, nu, displacement, underlying, underlying, maturity);
// Apply displacement. Displaced model is just a shift on underlying and strike.
underlying += displacement;
/*
double d1xdz1 = 1.0;
double d2xdz2 = rho;
double d3xdz3 = 3.0*rho*rho-1.0;
double d1zdK1 = -nu/alpha * Math.pow(underlying, -beta);
double d2zdK2 = + nu/alpha * beta * Math.pow(underlying, -beta-1.0);
double d3zdK3 = - nu/alpha * beta * (1.0+beta) * Math.pow(underlying, -beta-2.0);
double d1xdK1 = d1xdz1*d1zdK1;
double d2xdK2 = d2xdz2*d1zdK1*d1zdK1 + d1xdz1*d2zdK2;
double d3xdK3 = d3xdz3*d1zdK1*d1zdK1*d1zdK1 + 3.0*d2xdz2*d2zdK2*d1zdK1 + d1xdz1*d3zdK3;
double term1 = alpha * Math.pow(underlying, beta) / nu;
*/
final double d2Part1dK2 = nu * ((1.0/3.0 - 1.0/2.0 * rho * rho) * nu/alpha * Math.pow(underlying, -beta) + (1.0/6.0 * beta*beta - 2.0/6.0 * beta) * alpha/nu*Math.pow(underlying, beta-2));
final double d0BdK0 = (-1.0/24.0 *beta*(2-beta)*alpha*alpha*Math.pow(underlying, 2*beta-2) + 1.0/4.0 * beta*alpha*rho*nu*Math.pow(underlying, beta-1.0) + (2.0 -3.0*rho*rho)*nu*nu/24);
final double d1BdK1 = (-1.0/48.0 *beta*(2-beta)*(2*beta-2)*alpha*alpha*Math.pow(underlying, 2*beta-3) + 1.0/8.0 * beta*(beta-1.0)*alpha*rho*nu*Math.pow(underlying, beta-2));
final double d2BdK2 = (-1.0/96.0 *beta*(2-beta)*(2*beta-2)*(2*beta-3)*alpha*alpha*Math.pow(underlying, 2*beta-4) + 1.0/16.0 * beta*(beta-1)*(beta-2)*alpha*rho*nu*Math.pow(underlying, beta-3));
final double curvatureApproximation = nu/alpha * ((1.0/3.0 - 1.0/2.0 * rho * rho) * sigma*nu/alpha * Math.pow(underlying, -2*beta));
final double curvaturePart1 = nu/alpha * ((1.0/3.0 - 1.0/2.0 * rho * rho) * sigma*nu/alpha * Math.pow(underlying, -2*beta) + (1.0/6.0 * beta*beta - 2.0/6.0 * beta) * sigma*alpha/nu*Math.pow(underlying, -2));
final double curvatureMaturityPart = (rho*nu + alpha*beta*Math.pow(underlying, beta-1))*d1BdK1 + alpha*Math.pow(underlying, beta)*d2BdK2;
return (curvaturePart1 + maturity * curvatureMaturityPart);
}
/**
* Exact conversion of displaced lognormal ATM volatility to normal ATM volatility.
*
* @param forward The forward
* @param displacement The displacement (considering a displaced lognormal model, otherwise 0.
* @param optionMaturity The maturity
* @param lognormalVolatility The (implied) lognormal volatility.
* @return The (implied) normal volatility.
* @see Dimitroff, Fries, Lichtner and Rodi: Lognormal vs Normal Volatilities and Sensitivities in Practice
*/
public static double volatilityConversionLognormalATMtoNormalATM(final double forward, final double displacement, final double optionMaturity, final double lognormalVolatility) {
final double x = lognormalVolatility * Math.sqrt(optionMaturity / 8);
final double y = org.apache.commons.math3.special.Erf.erf(x);
final double normalVol = Math.sqrt(2*Math.PI / optionMaturity) * (forward+displacement) * y;
return normalVol;
}
/**
* Numerical conversion of displaced lognormal volatility to normal volatility.
*
* @param forward The forward.
* @param displacement The displacement (considering a displaced lognormal model, otherwise 0.
* @param optionMaturity The maturity.
* @param optionStrike The strike.
* @param lognormalVolatility The (implied) lognormal volatility.
* @return The (implied) normal volatility.
*/
public static double volatilityConversionLognormalToNormal(final double forward, final double displacement, final double optionMaturity, final double optionStrike, final double lognormalVolatility) {
final double payoffUnit = 1.0; // does not matter in this conversion
final double optionValue = blackScholesGeneralizedOptionValue(forward+displacement, lognormalVolatility, optionMaturity, optionStrike+displacement, payoffUnit);
final double impliedNormalVolatility = bachelierOptionImpliedVolatility(forward, optionMaturity, optionStrike, payoffUnit, optionValue);
return impliedNormalVolatility;
}
/**
* Re-implementation of the Excel PRICE function (a rather primitive bond price formula).
* The re-implementation is not exact, because this function does not consider daycount conventions.
*
* @param settlementDate Valuation date.
* @param maturityDate Maturity date of the bond.
* @param coupon Coupon payment.
* @param yield Yield (discount factor, using frequency: 1/(1 + yield/frequency).
* @param redemption Redemption (notional repayment).
* @param frequency Frequency (1,2,4).
* @return price Clean price.
*/
public static double price(
final java.util.Date settlementDate,
final java.util.Date maturityDate,
final double coupon,
final double yield,
final double redemption,
final int frequency)
{
double price = 0.0;
if(maturityDate.after(settlementDate)) {
price += redemption;
}
final Calendar paymentDate = Calendar.getInstance();
paymentDate.setTime(maturityDate);
while(paymentDate.after(settlementDate)) {
price += coupon;
// Discount back
price /= 1.0 + yield / frequency;
paymentDate.add(Calendar.MONTH, -12/frequency);
}
final Calendar periodEndDate = (Calendar)paymentDate.clone();
periodEndDate.add(Calendar.MONTH, +12/frequency);
// Accrue running period
final double accrualPeriod = (paymentDate.getTimeInMillis() - settlementDate.getTime()) / (periodEndDate.getTimeInMillis() - paymentDate.getTimeInMillis());
price *= Math.pow(1.0 + yield / frequency, accrualPeriod);
price -= coupon * accrualPeriod;
return price;
}
/**
* Re-implementation of the Excel PRICE function (a rather primitive bond price formula).
* The re-implementation is not exact, because this function does not consider daycount conventions.
* We assume we have (int)timeToMaturity/frequency future periods and the running period has
* an accrual period of timeToMaturity - frequency * ((int)timeToMaturity/frequency).
*
* @param timeToMaturity The time to maturity.
* @param coupon Coupon payment.
* @param yield Yield (discount factor, using frequency: 1/(1 + yield/frequency).
* @param redemption Redemption (notional repayment).
* @param frequency Frequency (1,2,4).
* @return price Clean price.
*/
public static double price(
final double timeToMaturity,
final double coupon,
final double yield,
final double redemption,
final int frequency)
{
double price = 0.0;
if(timeToMaturity > 0) {
price += redemption;
}
double paymentTime = timeToMaturity;
while(paymentTime > 0) {
price += coupon;
// Discount back
price = price / (1.0 + yield / frequency);
paymentTime -= 1.0 / frequency;
}
// Accrue running period
final double accrualPeriod = 0.0- paymentTime;
price *= Math.pow(1.0 + yield / frequency, accrualPeriod);
price -= coupon * accrualPeriod;
return price;
}
/**
* Calculates the vega of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a
* normal process with constant volatility, i.e., a Bachelier model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma \mathrm{d}W(t)
* \]
*
* @param forward The forward of the underlying \( F = S(0) \exp(r T) \).
* @param volatility The Bachelier volatility \( \sigma \).
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @param payoffUnit The payoff unit (e.g., the discount factor)
* @return Returns the vega of a European call option under the Bachelier model.
*/
public static double bachelierGeneralizedOptionVega(
final double forward,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double payoffUnit)
{
if(optionMaturity < 0) {
return 0;
}
else if(forward == optionStrike) {
return Math.sqrt(optionMaturity / (Math.PI * 2.0)) * payoffUnit;
}
else
{
// Calculate analytic value
final double dPlus = (forward - optionStrike) / (volatility * Math.sqrt(optionMaturity));
final double vegaAnalytic = Math.sqrt(optionMaturity) * NormalDistribution.density(dPlus) * payoffUnit;
return vegaAnalytic;
}
}
/**
* Calculates the vega of a call, i.e., the payoff max(S(T)-K,0) P, where S follows a
* normal process with constant volatility, i.e., a Black-Scholes model
* \[
* \mathrm{d} S(t) = r S(t) \mathrm{d} t + \sigma S(t)\mathrm{d}W(t)
* \]
*
* @param forward The forward of the underlying \( F = S(0) \exp(r T) \).
* @param volatility The Black-Scholes volatility \( \sigma \).
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @param payoffUnit The payoff unit (e.g., the discount factor)
* @return Returns the vega of a European call option under the Black-Scholes model.
*/
public static double blackScholesGeneralizedOptionVega(
final double forward,
final double volatility,
final double optionMaturity,
final double optionStrike,
final double payoffUnit)
{
if(optionStrike <= 0.0 || optionMaturity <= 0.0)
{
// The Black-Scholes model does not consider it being an option
return 0.0;
}
else
{
// Calculate vega
final double dPlus = (Math.log(forward / optionStrike) + (0.5 * volatility * volatility) * optionMaturity) / (volatility * Math.sqrt(optionMaturity));
final double vega = payoffUnit * NormalDistribution.density(dPlus) * forward * Math.sqrt(optionMaturity);
return vega;
}
}
/**
* Calculates the CEV option value of a call, i.e., the payoff max(S(T)-K,0), where S follows a CEV process.
* Formula is from 2007 - Hsu Lin Lee - 'Constant Elasticity of Variance Option Pricing Model'.
* CEV exponent must be between 0 and 1.
*
* @author Ralph Rudd
*
* @param initialStockValue The spot value of the underlying.
* @param riskFreeRate The risk free rate r (df = exp(-r T)).
* @param volatility The CEV volatility (NOT the log-normal volatility).
* @param exponent The exponent of S in the diffusion term.
* @param optionMaturity The option maturity T.
* @param optionStrike The option strike.
* @param isCall If true, the value of a call is calculated, if false, the value of a put is calculated.
* @return Returns the value of a European call option under the CEV model.
*/
public static double constantElasticityOfVarianceOptionValue(
double initialStockValue,
double riskFreeRate,
double volatility,
double exponent,
double optionMaturity,
double optionStrike,
boolean isCall) {
final double kappa = 2 * riskFreeRate / (Math.pow(volatility, 2) * (1 - exponent) * (Math.exp(2 * riskFreeRate * (1 - exponent) * optionMaturity) - 1));
final double z = 2 + 1 / (1 - exponent);
final double y = kappa * Math.pow(optionStrike, 2 * (1 - exponent));
final double x = kappa * Math.pow(initialStockValue, 2 * (1 - exponent)) * Math.exp(2 * riskFreeRate * (1 - exponent) * optionMaturity);
final NonCentralChiSquaredDistribution P1 = new NonCentralChiSquaredDistribution(z, x);
final NonCentralChiSquaredDistribution P2 = new NonCentralChiSquaredDistribution(z - 2, y);
if (isCall) {
return initialStockValue * (1 - P1.cumulativeDistribution(y)) - optionStrike * Math.exp(-riskFreeRate * optionMaturity) * P2.cumulativeDistribution(x);
} else {
return -initialStockValue * P1.cumulativeDistribution(y) + optionStrike * Math.exp(-riskFreeRate * optionMaturity) * (1 - P2.cumulativeDistribution(x));
}
}
}