Left-wing asymptotics of the implied volatility in the presence of atoms

Abstract: We consider the asymptotic behavior of the implied volatility in stochastic asset price models with atoms. In such models, the asset price distribution has a singular component at zero. Examples of models with atoms include the constant elasticity of variance model, jump-to-default models, and stochastic models described by processes stopped at the first hitting time of zero. For models with atoms, the behavior of the implied volatility at large strikes is similar to that in models without atoms. On the other hand, the behavior of the implied volatility at small strikes is influenced significantly by the atom at zero. S. De Marco, C. Hillairet, and A. Jacquier found an asymptotic formula for the implied volatility at small strikes with two terms and also provided an incomplete description of the third term. In the present paper, we obtain a new asymptotic formula for the left wing of the implied volatility, which is qualitatively different from the De Marco-Hillairet-Jacquier formula. The new formula contains three explicit terms and an error estimate. We show how to derive the De Marco-Hillairet-Jacquier formula from our formula, and compare the performance of the two formulas in the case of the CEV model. The resulting graphs show that the new formula provides a notably better approximation to the smile in the CEV model than the De Marco-Hillairet-Jacquier formula.