Venturing into uncharted territory: An extensible implied volatility surface model

Pascal François, Rémi Galarneau‐Vincent, Geneviève Gauthier and Frédéric Godin

Journal of Futures Markets, 2022, vol. 42, issue 10, 1912-1940

Abstract: A new factor‐based representation of implied volatility (IV) surfaces is proposed. The factors adequately capture the moneyness and maturity slopes, the smile attenuation, and the smirk. Furthermore, the IV specification is twice continuously differentiable and well‐behaved asymptotically, allowing for clean interpolation and extrapolation over a wide range of moneyness and maturity. Fitting performance on Standard and Poor's 500 options compares favorably with existing benchmarks. The benefits of a smoothed IV surface are illustrated through the valuation of illiquid index derivatives, the extraction of the risk‐neutral density and risk‐neutral moments, and the calculation of option price sensitivities.

Date: 2022
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