Implied volatility string dynamics
AbstractA primary goal in modelling the dynamics of implied volatility surfaces (IVS) aims at reducing complexity. For this purpose one fits the IVS each day and applies a principal component analysis using a functional norm. This approach, however, neglects the degenerated string structure of the implied volatility data and may result in a severe modelling bias. We propose a dynamic semiparametric factor model, which approximates the IVS in a finite dimensional function space. The key feature is that we only fit in the local neighborhood of the design points. Our approach is a combination of methods from functional principal component analysis and backfitting techniques for additive models. The model is found to have an approximate 10% better performance than the typical näive trader models. The model can be a backbone in risk management serving for value at risk computations and scenario analysis. --
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Bibliographic InfoPaper provided by Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes in its series SFB 373 Discussion Papers with number 2003,54.
Date of creation: 2003
Date of revision:
Implied Volatility Surface; Smile; Generalized Additive Models; Backfitting; Functional Principal Component Analysis;
Find related papers by JEL classification:
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
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