Local Volatility

Local volatility is a model used in finance to estimate how the volatility—or the degree of price fluctuation—of an asset varies across different prices and times. Unlike a constant volatility assumption, local volatility recognizes that market conditions cause volatility to change depending on the current asset price and time. This allows traders to more accurately price and hedge options by capturing the unique, evolving risk profile of an underlying asset, leading to better risk management and pricing precision in volatile markets.