ANALYSIS OF MARKET VOLATILITY VIA A DYNAMICALLY PURIFIED OPTION PRICE PROCESS

Chuong Luong () and Nikolai Dokuchaev ()
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Chuong Luong: Department of Mathematics & Statistics, Curtin University, GPO Box U1987, Perth 6845, Western Australia, Australia
Nikolai Dokuchaev: Department of Mathematics & Statistics, Curtin University, GPO Box U1987, Perth 6845, Western Australia, Australia

Annals of Financial Economics (AFE), 2014, vol. 09, issue 03, 1-19

Abstract: The paper studies methods of dynamic estimation of volatility for financial time series. We suggest to estimate the volatility as the implied volatility inferred from some artificial "dynamically purified" price process that in theory allows to eliminate the impact of the stock price movements. The complete elimination would be possible if the option prices were available for continuous sets of strike prices and expiration times. In practice, we have to use only finite sets of available prices. We discuss the construction of this process from the available option prices using different methods. In order to overcome the incompleteness of the available option prices, we suggests several interpolation approaches, including the first order Taylor series extrapolation and quadratic interpolation. We examine the potential of the implied volatility derived from this proposed process for forecasting of the future volatility, in comparison with the traditional implied volatility process such as the volatility index VIX.

Keywords: Econometrics; implied volatility; volatility index; approximation of missing data; dynamic forecasting; purified option prices (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (1)

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DOI: 10.1142/S2010495214500067

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