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Risk modeling with option-implied correlations and score-driven dynamics

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  • Marco Piña
  • Rodrigo Herrera

Abstract

In this paper we make use of option-implied volatilities to build a time-varying implied correlation matrix. Then, we use this matrix to estimate jointly both the covariance matrix of the returns and the implied covariance matrix dynamics. Finally, we do a backtest and show that the proposed model can effectively use the risk-neutral information to model the variance of the returns and to forecast the Value-at-Risk. Our results show that the model obtains results comparable to the benchmark while considerably reducing the number of estimated parameters.

Suggested Citation

  • Marco Piña & Rodrigo Herrera, 2021. "Risk modeling with option-implied correlations and score-driven dynamics," Working Papers Central Bank of Chile 932, Central Bank of Chile.
    • Handle: RePEc:chb:bcchwp:932
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    File URL: https://www.bcentral.cl/documents/33528/133326/DTBC_932.pdf
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    References listed on IDEAS

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