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Author: Rama Cont
Publisher:
ISBN:
Category :
Languages : en
Pages : 36
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Book Description
The prices of index options at a given date are usually represented via the corresponding implied volatility surface, presenting skew/smile features and term structure which several models have attempted to reproduce. However the implied volatility surface also changes dynamically over time in a way that is not taken into account by current modeling approaches, giving rise to quot;Vegaquot; risk in option portfolios. Using time series of option prices on the SP500 and FTSE indices, we study the deformation of this surface and show that it may be represented as a randomly fluctuating surface driven by a small number of orthogonal random factors. We identify and interpret the shape of each of these factors, study their dynamics and their correlation with the underlying index. Our approach is based on a Karhunen-Loeve decomposition of the daily variations of implied volatilities obtained from market data. A simple factor model compatible with the empirical observations is proposed. We illustrate how this approach model and improves the the well-known quot;sticky moneynessquot; rule used by option traders for updating implied volatilities. Our approach gives a justification for use of quot;Vegasquot; for measuring volatility risk and provides a decomposition of volatility risk as a sum of contributions from empirically identifiable factors.
Author: Rama Cont
Publisher:
ISBN:
Category :
Languages : en
Pages : 36
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Book Description
The prices of index options at a given date are usually represented via the corresponding implied volatility surface, presenting skew/smile features and term structure which several models have attempted to reproduce. However the implied volatility surface also changes dynamically over time in a way that is not taken into account by current modeling approaches, giving rise to quot;Vegaquot; risk in option portfolios. Using time series of option prices on the SP500 and FTSE indices, we study the deformation of this surface and show that it may be represented as a randomly fluctuating surface driven by a small number of orthogonal random factors. We identify and interpret the shape of each of these factors, study their dynamics and their correlation with the underlying index. Our approach is based on a Karhunen-Loeve decomposition of the daily variations of implied volatilities obtained from market data. A simple factor model compatible with the empirical observations is proposed. We illustrate how this approach model and improves the the well-known quot;sticky moneynessquot; rule used by option traders for updating implied volatilities. Our approach gives a justification for use of quot;Vegasquot; for measuring volatility risk and provides a decomposition of volatility risk as a sum of contributions from empirically identifiable factors.
Author: Les Clewlow
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
Motivated by the papers of Dupire (1992) and Derman and Kani (1997), we want to investigate the number of shocks that move the whole implied volatility surface, their interpretation and their correlation with percentage changes in the underlying asset. This work differs from Skiadopoulos, Hodges and Clewlow (1998) in which they looked at the dynamics of smiles for a given maturity bucket. We look at daily changes in implied volatilities under two different metrics: the strike metric and the moneyness metric. Since we are dealing with a three dimensional problem, we fix ranges of days to maturity, we pool them together and we apply the Principal Components Analysis (PCA) to the changes in implied volatilities over time across both the strike (moneyness) metric and the pooled ranges of days to maturity. We find similar results for both metrics. Two shocks explain the movements of the volatility surface, the first shock being interpreted as a shift, while the second one has a Z-shape. The sign of the correlation of the first shock with percentage changes in the underlying asset depends on the metric that we look at, while the sign is positive under both metrics regarding the second shock. The results suggest that the number of shocks, their interpretation and the sign of their correlation with changes in the underlying asset is the same for the whole implied volatility surface as it is for the smile corresponding to a fixed maturity bucket.
Author: Ihsan Badshah
Publisher:
ISBN:
Category :
Languages : en
Pages : 0
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Book Description
The purpose of this study is to model implied volatility surfaces and identify risk factors that account for most of the randomness in the volatility surfaces. The approach is similar to that of the Dumas, Fleming and Whaley (DFW) (1998) study. We use moneyness in implied forward price and out-of-the-money put-call options on the FTSE 100 stock index. After adjustments, a nonlinear parametric optimization technique is used to estimate different DFW models to characterize and produce smooth implied volatility surfaces. Next, principal component analysis is applied to the implied volatility surfaces to extract principal components that account for most of the dynamics in the shape of the surfaces. We then estimate and obtain smooth implied volatility surfaces with the parametric models that account for both smirk(skew) and time to maturity. We find the constant volatility model fails to explain the variations in the surfaces. However, the first three principal components (or factors) can explain about 69-88% of the variances in the implied volatility surfaces: in which on average 56% explains by the level factor, 15% by the term structure factor, and additional 7% by the jump-fear factor. The applications of our study can be in options trading, hedging of derivatives positions, risk management of options, and policy making.
Author: Jim Gatheral
Publisher: John Wiley & Sons
ISBN: 1118046455
Category : Business & Economics
Languages : en
Pages : 204
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Book Description
Praise for The Volatility Surface "I'm thrilled by the appearance of Jim Gatheral's new book The Volatility Surface. The literature on stochastic volatility is vast, but difficult to penetrate and use. Gatheral's book, by contrast, is accessible and practical. It successfully charts a middle ground between specific examples and general models--achieving remarkable clarity without giving up sophistication, depth, or breadth." --Robert V. Kohn, Professor of Mathematics and Chair, Mathematical Finance Committee, Courant Institute of Mathematical Sciences, New York University "Concise yet comprehensive, equally attentive to both theory and phenomena, this book provides an unsurpassed account of the peculiarities of the implied volatility surface, its consequences for pricing and hedging, and the theories that struggle to explain it." --Emanuel Derman, author of My Life as a Quant "Jim Gatheral is the wiliest practitioner in the business. This very fine book is an outgrowth of the lecture notes prepared for one of the most popular classes at NYU's esteemed Courant Institute. The topics covered are at the forefront of research in mathematical finance and the author's treatment of them is simply the best available in this form." --Peter Carr, PhD, head of Quantitative Financial Research, Bloomberg LP Director of the Masters Program in Mathematical Finance, New York University "Jim Gatheral is an acknowledged master of advanced modeling for derivatives. In The Volatility Surface he reveals the secrets of dealing with the most important but most elusive of financial quantities, volatility." --Paul Wilmott, author and mathematician "As a teacher in the field of mathematical finance, I welcome Jim Gatheral's book as a significant development. Written by a Wall Street practitioner with extensive market and teaching experience, The Volatility Surface gives students access to a level of knowledge on derivatives which was not previously available. I strongly recommend it." --Marco Avellaneda, Director, Division of Mathematical Finance Courant Institute, New York University "Jim Gatheral could not have written a better book." --Bruno Dupire, winner of the 2006 Wilmott Cutting Edge Research Award Quantitative Research, Bloomberg LP
Author: Jim Gatheral
Publisher:
ISBN: 9781119202073
Category : Options (Finance)
Languages : en
Pages : 179
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Book Description
Author: Jacinto Marabel Romo
Publisher:
ISBN:
Category :
Languages : en
Pages : 22
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Book Description
I perform a regression analysis to test two of the most famous heuristic rules existing in the literature about the behavior of the implied volatility surface. These rules are the sticky delta rule and the sticky strike rule. I present a new specification to test the sticky strike rule, which allows for dynamics in the implied volatility surface. In the empirical application I use monthly implied volatility surfaces corresponding to the IBEX 35 index. The estimation results show that the extended specification for the sticky strike rule presented in this article represents better the behavior of the implied volatility under this rule. Furthermore, there is not one rule which is the most appropriate at all times to explain the evolution of implied volatility surface. Depending on the market situation a rule may be more appropriate than another one. In particular, when the underlying asset displays trend, the sticky delta rule tends to prevail against the sticky strike rule. Conversely, when the underlying asset moves in range, then the sticky strike rule tends to predominate.
Author: Daniel Schmid
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
This paper finds that the dynamics of implied volatility can be forecasted to a certain extent during a period of crisis. The forecasts are achieved using a dimensionality reduction method known as principal component analysis. While the forecasts in terms of the amplitude of change do not outperform a random walk process, the direction of change can be predicted correctly in a statistically significant way with an average of 51.70% for all levels of time to maturity and moneyness. A trading model based on these forecasts is then presented and generates significant profits for low maturities, with an average daily return of 1.462% for options with a maturity of one week. The profits generated for options with a maturity of one year are no longer significant. This is explained by analysing the exposure to different risk parameters our portfolios bare. This paper concludes that accurately forecasting the dynamics of implied volatility might be sufficient in periods of great economic instability and underlines the need to develop accurate risk management tools to account for changes in the underlying price.
Author: Alejandro Bernales
Publisher:
ISBN:
Category :
Languages : en
Pages : 40
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Book Description
We examine whether the dynamics of the implied volatility surface of individual equity options contains exploitable predictability patterns. Predictability in implied volatilities is expected due to the learning behavior of agents in option markets. In particular, we explore the possibility that the dynamics of the implied volatility surface of individual equity options may be associated with movements in the volatility surface of S&P 500 index options. We present evidence of strong predictable features in the cross-section of equity options and of dynamic linkages between the implied volatility surfaces of equity options and S&P 500 index options. Moreover, time-variations in stock option volatility surfaces are best predicted by incorporating information from the dynamics in the implied volatility surface of S&P 500 index options. We analyze the economic value of such dynamic patterns using strategies that trade straddle and delta-hedged portfolios, and we find that before transaction costs such strategies produce abnormal risk-adjusted returns.
Author: Ricardo Baeza-Yates
Publisher: Springer Science & Business Media
ISBN: 0387233946
Category : Mathematics
Languages : en
Pages : 497
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Book Description
Applied probability is a broad research area that is of interest to scientists in diverse disciplines in science and technology, including: anthropology, biology, communication theory, economics, epidemiology, finance, geography, linguistics, medicine, meteorology, operations research, psychology, quality control, sociology, and statistics. Recent Advances in Applied Probability is a collection of survey articles that bring together the work of leading researchers in applied probability to present current research advances in this important area. This volume will be of interest to graduate students and researchers whose research is closely connected to probability modelling and their applications. It is suitable for one semester graduate level research seminar in applied probability.
Author: George S. Skiadopoulos
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
This empirical study is motivated by the literature on quot;smile-consistentquot; arbitrage pricing with stochastic volatility. We investigate the number and shape of shocks that move implied volatility smiles and surfaces by applying Principal Components Analysis. Two components are identified under a variety of criteria. Subsequently, we develop a quot;Procrustesquot; type rotation in order to interpret the retained components. The results have implications for both option pricing and hedging and for the economics of option pricing.
