Local Volatility


DEFINITION of 'Local Volatility'

A model used in quantitative finance to calculate the unpredictability of the underlying current asset of a financial derivative. Because of the treatment of the underlying asset price as the sole random variable, local volatility models are not suitable for the pricing of all options, such as cliquet options.

Local variance, another calculation used in quantitative finance, is the square of local volatility.

BREAKING DOWN 'Local Volatility'

Local volatility models are often used alongside stochastic volatility models in order to compare assumptions on different derivative valuations. The local volatility model "knows" volatilities in advance, while in stochastic volatility models volatility is treated as an uncertainty. The concept of local volatility was put forth by Emanuel Derman and Iraj Kani.

  1. Financial Modeling

    The process by which a firm constructs a financial representation ...
  2. Cliquet

    An extended exotic option that periodically settles and resets ...
  3. Black Scholes Model

    A model of price variation over time of financial instruments ...
  4. Binomial Tree

    A graphical representation of possible intrinsic values that ...
  5. Option Pricing Theory

    Any model- or theory-based approach for calculating the fair ...
  6. Binomial Option Pricing Model

    An options valuation method developed by Cox, et al, in 1979. ...
Related Articles
  1. Options & Futures

    Breaking Down The Binomial Model To Value An Option

    Find out how to carve your way into this valuation model niche.
  2. Options & Futures

    The "True" Cost Of Stock Options

    Perhaps the real cost of employee stock options is already accounted for in the expense of buyback programs.
  3. Options & Futures

    The Benefits And Value Of Stock Options

    The pros and cons of corporate stock options have been debated since the incentive was created. Learn more about stock option basics and the cost of stock options.
  4. Options & Futures

    Understanding Option Pricing

    Take advantage of stock movements by getting to know these derivatives.
  5. Options & Futures

    The ABCs Of Option Volatility

    The mystery of options pricing can often be explained by a look at implied volatility (IV).
  6. Credit & Loans

    Pre-Qualified Vs. Pre-Approved - What's The Difference?

    These terms may sound the same, but they mean very different things for homebuyers.
  7. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  8. Insurance

    Cashing in Your Life Insurance Policy

    Tough times call for desperate measures, but is raiding your life insurance policy even worth considering?
  9. Fundamental Analysis

    Using Decision Trees In Finance

    A decision tree provides a comprehensive framework to review the alternative scenarios and consequences a decision may lead to.
  10. Economics

    Understanding Tragedy of the Commons

    The tragedy of the commons describes an economic problem in which individuals try to reap the greatest benefits from a given resource.
  1. Do plane tickets get cheaper closer to the date of departure?

    The price of flights usually increases one month prior to the date of departure. Flights are usually cheapest between three ... Read Full Answer >>
  2. How do hedge funds use equity options?

    With the growth in the size and number of hedge funds over the past decade, the interest in how these funds go about generating ... Read Full Answer >>
  3. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  4. Is Colombia an emerging market economy?

    Colombia meets the criteria of an emerging market economy. The South American country has a much lower gross domestic product, ... Read Full Answer >>
  5. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  6. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  2. Bullish Engulfing Pattern

    A chart pattern that forms when a small black candlestick is followed by a large white candlestick that completely eclipses ...
  3. Cyber Monday

    An expression used in online retailing to describe the Monday following U.S. Thanksgiving weekend. Cyber Monday is generally ...
  4. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
Trading Center