Demystifying the Bergomi-Guyon expansion

Abstract

Alòs, Gatheral and Radoičić derived the Bergomi-Guyon expansion of the implied variance smile from the forest expansion of the cumulant generating function. Its coefficients are sums of products of diamond trees, with prefactors that are polynomials in the log-strike $k$. Matching moments order by order produces, at order $ε^\ell$, terms of degree greater than $\ell$ in $k$ that mysteriously cancel. We show that, in suitable variables, the matching condition can be formulated as a nonlinear heat equation. The resulting recursion computes the prefactor of each product of trees from those of products of fewer trees, without generating the higher-degree terms; its only model-independent input is a cumulant series, which we compute in closed form. Consequently, at order $ε^\ell$ every prefactor has degree exactly $\ell$ in $k$. The prefactors are universal and need only be computed once. Code and coefficients are provided.