Dynamic Factor Models for the Volatility Surface

Michel van der Wel, Sait R. Ozturk, Dick van Dijk

Research output: Contribution to book/anthology/report/proceedingBook chapterResearchpeer-review

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 Δ is preferred over the more often used strike relative to spot price as measure for moneyness.

Original languageEnglish
Title of host publicationAdvances in Econometrics
EditorsEric Hillebrand, Siem Jan Koopman
Number of pages48
Volume35
Place of publicationBingley
PublisherEmerald Group Publishing
Publication date2016
Pages127-174
ISBN (Print)978-1-78560-353-2
DOIs
Publication statusPublished - 2016
SeriesAdvances in Econometrics
Volume35
ISSN0731-9053

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