THE TERM STRUCTURE OF IMPLIED VOLATILITY IN SYMMETRIC MODELS WITH APPLICATIONS TO HESTON

Abstract

We study the term structure of the implied volatility in the presence of a symmetric smile. Exploiting the result by Tehranchi (2009) that a symmetric smile generated by a continuous martingale necessarily comes from a mixture of normal distributions, we derive representation formulae for the at-the-money (ATM) implied volatility level and curvature in a general symmetric model. As a result, the ATM curve is directly related to the Laplace transform of the realized variance. The representation formulae for the implied volatility and its curvature take semi-closed form as soon as this Laplace transform is known explicitly. To deal with the rest of the volatility surface, we build a time dependent SVI-type (Gatheral, 2004) model which matches the ATM and extreme moneyness structure. As an instance of a symmetric model, we consider uncorrelated Heston: in this framework, the SVI approximation displays considerable performances in a wide range of maturities and strikes. All these results can be applied to skewed smiles by considering a displaced model. Finally, a noteworthy fact is that all along the paper we avoid dealing with any complex-valued function.