Using Discrete Local Volatilities for Arbitrage Repair with Gleam

Co-written by Magnus Wiese

TL;DR

• Arbitrageable prices do not allow for a proper evaluation / modeling of risks. Even more, cleaning / repairing option prices from arbitrage is a tedious task.
• The DLV algorithm is a linear program that repairs arbitrage and solves for the globally closest price lattice.
• The option price parametrization reduces the complex no-arbitrage conditions: if the (discrete) backward local volatilities are positive…