The Dynamics of Implied Volatilities: A Common Principal Components Approach
AbstractIt is common practice to identify the number and sources of shocks that move, e.g., ATM implied volatilities by principal components analysis. This approach, however, is likely to result in a loss of information, since the surface structure of implied volatilities is neglected. In this paper we analyze the implied volatility surface along maturity slices with a common principal components analysis (CPC), known from morphometrics. In CPC analysis, the space spanned by the eigenvectors is identical across groups, whereas variances associated with the common principal components vary. Our analysis shows that implied volatility surface dynamics can be traced back to a common eigenstructure in maturity slices. This empirical result is used to set up a factor model for implied volatility surface dynamics. Copyright Kluwer Academic Publishers 2003
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Bibliographic InfoArticle provided by Springer in its journal Review of Derivatives Research.
Volume (Year): 6 (2003)
Issue (Month): 3 (October)
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Web page: http://www.springerlink.com/link.asp?id=102989
common principal component analysis; principal component analysis; factor model; implied volatility surface; smile;
Other versions of this item:
- Fengler, Matthias R. & Härdle, Wolfgang K. & Villa, Christophe, 2001. "The dynamics of implied volatilities: A common principal components approach," SFB 373 Discussion Papers 2001,38, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- C49 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Other
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
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