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Forecasting Implied Volatility Surfaces

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  • Francesco Audrino

    ()

  • Dominik Colagelo

    ()

Abstract

We propose a new semi-parametric model for the implied volatility surface, which incorporates machine learning algorithms. Given a starting model, a tree-boosting algorithm sequentially minimizes the residuals of observed and estimated implied volatility. To overcome the poor predicting power of existing models, we include a grid in the region of interest, and implement a cross-validation strategy to find an optimal stopping value for the tree boosting. Back testing the out-of-sample appropriateness of our model on a large data set of implied volatilities on S&P 500 options, we provide empirical evidence of its strong predictive potential, as well as comparing it to other standard approaches in the literature.

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File URL: http://www1.vwa.unisg.ch/RePEc/usg/dp2007/DP-42-Au.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2007 with number 2007-42.

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Length: 38 pages
Date of creation: Nov 2007
Date of revision:
Handle: RePEc:usg:dp2007:2007-42

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Related research

Keywords: Implied Volatility; Implied Volatility Surface; Forecasting; Tree Boosting; Regression Tree; Functional Gradient Descent;

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References

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  1. Fengler, Matthias R. & Härdle, Wolfgang & Mammen, Enno, 2003. "Implied volatility string dynamics," SFB 373 Discussion Papers 2003,54, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
  2. Francesco Audrino, 2005. "The Stability of Factor Models of Interest Rates," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(3), pages 422-441.
  3. Rama Cont & Jose da Fonseca, 2002. "Dynamics of implied volatility surfaces," Quantitative Finance, Taylor and Francis Journals, vol. 2(1), pages 45-60.
  4. Ser-Huang Poon & Clive W.J. Granger, 2003. "Forecasting Volatility in Financial Markets: A Review," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 478-539, June.
  5. Silvia Goncalves & Massimo Guidolin, 2005. "Predictable dynamics in the S&P 500 index options implied volatility surface," Working Papers 2005-010, Federal Reserve Bank of St. Louis.
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