Abstract
AbstractWe present an optimal control approach using a Lagrangian framework to identify local volatility functions from given option prices. We employ a globalized sequential quadratic programming (SQP) algorithm and implement a line search strategy. The linear‐quadratic optimal control problems in each iteration are solved by a primal‐dual active set strategy which leads to a semi‐smooth Newton method. We present first‐ and second‐order analysis as well as numerical results. (© 2008 WILEY‐VCH Verlag GmbH & Co. KGaA, Weinheim)
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