Dynamic Factor Models for the Volatility Surface
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ISBN: 978-1-78560-353-2, eISBN: 978-1-78560-352-5
Publication date: 6 January 2016
Abstract
The implied volatility surface is the collection of volatilities implied by option contracts for different strike prices and time-to-maturity. We study factor models to capture the dynamics of this three-dimensional implied volatility surface. Three model types are considered to examine desirable features for representing the surface and its dynamics: a general dynamic factor model, restricted factor models designed to capture the key features of the surface along the moneyness and maturity dimensions, and in-between spline-based methods. Key findings are that: (i) the restricted and spline-based models are both rejected against the general dynamic factor model, (ii) the factors driving the surface are highly persistent, and (iii) for the restricted models option Δ is preferred over the more often used strike relative to spot price as measure for moneyness.
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Acknowledgements
Acknowledgments
We would like to thank the editors, two referees and participants at the 16th Annual Advances in Econometrics conference for their comments. Michel van der Wel is grateful to Netherlands Organisation for Scientific Research (NWO) for a Veni grant; and acknowledges support from CREATES, funded by the Danish National Research Foundation.
Citation
van der Wel, M., Ozturk, S.R. and van Dijk, D. (2016), "Dynamic Factor Models for the Volatility Surface
Publisher
:Emerald Group Publishing Limited
Copyright © 2016 Emerald Group Publishing Limited