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Model-Free Implied Volatility under Jump-Diffusion Models

Author

Listed:
  • Seungmook Choi

    (Lee Business School, University of Nevada, Las Vegas)

  • Hongtao Yang

    (Center for Applied Mathematics and Statistics, University of Nevada, Las Vegas)

Abstract

The model-free implied volatility (MFIVol) is intended to measure the variability of underlying asset price on which options are written. Analytically, however, it does not measure exactly the variability under jump diffusion. Our extensive empirical study suggests that the approximation error can be as much as about 3%-5% although most samples over the data period exhibit less than 1% errors. Even with the non-negligible errors, the MFIVol may be still considered a valid volatility measure from the perspective of risk-neutral return density, in the sense that it is bounded by the two variability measures as well as reflecting the shape of the risk-neutral density via its higher central moments.

Suggested Citation

  • Seungmook Choi & Hongtao Yang, 2019. "Model-Free Implied Volatility under Jump-Diffusion Models," Review of Economics & Finance, Better Advances Press, Canada, vol. 16, pages 1-14, May.
    • Handle: RePEc:bap:journl:190201
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    References listed on IDEAS

    as
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    Cited by:

    1. Fabian Woebbeking, 2021. "Cryptocurrency volatility markets," Digital Finance, Springer, vol. 3(3), pages 273-298, December.

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    More about this item

    Keywords

    Jump-diffusion model; Model-free Implied Volatility; Risk-neutral probability density; Volatility index (VIX);
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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