The Dynamics of Implied Volatilities: A Common Principal Components Approach

Matthias Fengler, Wolfgang Härdle and Christophe Villa

Review of Derivatives Research, 2003, vol. 6, issue 3, 179-202

Abstract: It is common practice to identify the number and sources of shocks that move, e.g., ATM implied volatilities by principal components analysis. This approach, however, is likely to result in a loss of information, since the surface structure of implied volatilities is neglected. In this paper we analyze the implied volatility surface along maturity slices with a common principal components analysis (CPC), known from morphometrics. In CPC analysis, the space spanned by the eigenvectors is identical across groups, whereas variances associated with the common principal components vary. Our analysis shows that implied volatility surface dynamics can be traced back to a common eigenstructure in maturity slices. This empirical result is used to set up a factor model for implied volatility surface dynamics. Copyright Kluwer Academic Publishers 2003

Keywords: common principal component analysis; principal component analysis; factor model; implied volatility surface; smile (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (56)

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Working Paper: The dynamics of implied volatilities: a common principal components approach (2003)
Working Paper: The dynamics of implied volatilities: A common principal components approach (2001)
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DOI: 10.1023/B:REDR.0000004823.77464.2d

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