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Dynamic Factor Models for the Volatility Surface

Michel van der Wel (), Sait Ozturk and Dick van Dijk ()

A chapter in Dynamic Factor Models, 2016, vol. 35, pp 127-174 from Emerald Publishing Ltd

Abstract: Abstract The implied volatility surface is the collection of volatilities implied by option contracts for different strike prices and time-to-maturity. We study factor models to capture the dynamics of this three-dimensional implied volatility surface. Three model types are considered to examine desirable features for representing the surface and its dynamics: a general dynamic factor model, restricted factor models designed to capture the key features of the surface along the moneyness and maturity dimensions, and in-between spline-based methods. Key findings are that: (i) the restricted and spline-based models are both rejected against the general dynamic factor model, (ii) the factors driving the surface are highly persistent, and (iii) for the restricted models option ? is preferred over the more often used strike relative to spot price as measure for moneyness.

Keywords: Dynamic factor models; implied volatility surface; Kalman filter; maximum likelihood; C32; C58; G13 (search for similar items in EconPapers)
Date: 2016
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Working Paper: Dynamic Factor Models for the Volatility Surface (2015) Downloads
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