Forecasting Parameters in the SABR Model

Li Chen, Jianing Zhu and Cunyi Yang
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Li Chen: Lingnan College, Sun Yat-Sen University, Guangzhou, China
Jianing Zhu: Paul Merage School of Business, University of California, Irvine, USA

Journal of Economic Analysis, 2022, vol. 1, issue 1, 66-78

Abstract: We present two approaches to forecasting parameters in the SABR model. The first approach is the vector autoregressive moving-average model (VARMA) for the time series of the in-sample calibrated parameters, and the second is based on machine learning techniques called epsilon-support vector regression (ε-SVR). Using daily data of S&P 500 ETF option prices from January 1, 2014, to December 31, 2018, we first calibrate the daily values of the model parameters from the training sample, then conduct out-of-sample forecasting of parameters and pricing of options. Both approaches produce good fits between the forecasted and calibrated parameters for out-of-sample dates. A comparison study shows that using forecasted parameters as inputs, the SABR model generates better pricing results than assuming constant parameters or using lag parameters. We also discuss the market conditions under which one approach outperforms the other.

Keywords: SABR model; VARMA; ε-SVR; Implied volatility; Machine learning; Time-series econometrics (search for similar items in EconPapers)
Date: 2022
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