A Dynamic Copula Approach to Recovering the Index Implied Volatility Skew
Abstract
Equity index implied volatility functions are known to be excessively skewed in comparison with implied volatility at the single stock level. We study this stylized fact for the case of a major German stock index, the DAX, by recovering index implied volatility from simulating the 30-dimensional return system of all DAX constituents. Option prices are computed after risk neutralization of the multivariate process which is estimated under the physical probability measure. The multivariate models belong to the class of copula asymmetric dynamic conditional correlation models. We show that moderate tail dependence coupled with asymmetric correlation response to negative news is essential to explain the index implied volatility skew. Standard dynamic correlation models with zero tail dependence fail to generate a sufficiently steep implied volatility skew. Copyright The Author 2012. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.Download Info
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Bibliographic Info
Article provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.
Volume (Year): 10 (2012)
Issue (Month): 3 (June)
Pages: 457-493
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Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Martín Saldías, 2012.
"Systemic Risk Analysis using Forward-Looking Distance-to-Default Series,"
Working Papers
w201216, Banco de Portugal, Economics and Research Department.
- Martin Saldías Zambrana, 2010. "Systemic risk analysis using forward-looking distance-to-default series," Working Paper 1005, Federal Reserve Bank of Cleveland.
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