Department of Economics and Business Economics

Dynamic Factor Models for the Volatility Surface

Research output: Working paperResearch

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  • rp15_13

    Submitted manuscript, 1 MB, PDF document

  • Michel van der Wel, Erasmus University Rotterdam, Netherlands
  • Sait R. Ozturk, Erasmus University Rotterdam, Netherlands
  • Dick van Dijk, Erasmus University Rotterdam, Netherlands
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, (iii) for the restricted models option Delta is preferred over the more often used strike relative to spot price as measure for moneyness.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages44
Publication statusPublished - 2 Mar 2015
SeriesCREATES Research Papers
Number2015-13

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