Volatility surfaces: theory, rules of thumb, and empirical evidence

Toby Daglish (), John Hull and Wulin Suo

Quantitative Finance, 2007, vol. 7, issue 5, 507-524

Abstract: Implied volatilities are frequently used to quote the prices of options. The implied volatility of a European option on a particular asset as a function of strike price and time to maturity is known as the asset's volatility surface. Traders monitor movements in volatility surfaces closely. In this paper we develop a no-arbitrage condition for the evolution of a volatility surface. We examine a number of rules of thumb used by traders to manage the volatility surface and test whether they are consistent with the no-arbitrage condition and with data on the trading of options on the S&P 500 taken from the over-the-counter market. Finally we estimate the factors driving the volatility surface in a way that is consistent with the no-arbitrage condition.

Keywords: Implied volatility; Volatility surface; Dynamics; No-arbitrage; Empirical results (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (21)

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DOI: 10.1080/14697680601087883

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