K. Ilinski: Key results in financial economics

Stochastic Volatility Membrane – market model of the whole volatility surface as stochastic deformations of local volatility

Practical development of Derman-Kani model for the purpose of pricing exotic options. The model explicitly recognizes the fact that different areas of implied volatility surface are driven by different market factors and cannot be described by the dynamics of pure short-term volatility (as done in stochastic local volatility models – get the wrong model, force model to calibrate to unrealistic and unstable values of parameters and blame the market later!).

K.Ilinski and O. Soloviev, “Stochastic Volatility Membrane”, Wilmott, March 2004, 74-81

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