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Principal Component Analysis of Volatility Smiles and Skews

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Author Info
Carol Alexander () (ICMA Centre, University of Reading)

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Abstract

Several principal component models of volatility smiles and skews have been based on daily changes in implied volatilities, by strike and/or by moneyness. Derman and Kamal (1997) analyze S&P500 and Nikkei 225 index options where the daily change in the volatility surface is specified by delta and maturity. Skiadopoulos, Hodges and Clewlow (1998) apply PCA to first differences of implied volatilities for fixed maturity buckets, across both strike and moneyness metrics. And Fengler et. al. (2000) employ a common PCA that allows options on equities in the DAX of different maturities to be analyzed simultaneously.

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Publisher Info
Paper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2000-10.

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Length: 18 pages
Date of creation: Jun 2000
Date of revision: Jun 2001
Handle: RePEc:rdg:icmadp:icma-dp2000-10

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