Abstract: The (implied) volatility surface is the collection of option-implied volatilities for different strike prices and maturities. Existing literature documents that the volatility surface can be modelled by a limited number of factors using simple regression techniques, and that these factors are persistent. The put-call parity for options prescribes a strong relation for put and call options with the same moneyness and maturity. We propose a new equilibrium-correction based model for the volatility surface that extends the existing factor approach while explicitly benefitting from the predictive power of put-call parity deviations. We apply the model to S&P500 index options and options of 95 stocks, and show that the new model improves the existing model with a 40% decrease of in-sample RMSE and 30% for out-of-sample RMSFE. The economic significance evaluation shows that the new model can generate higher Sharpe ratio than existing model.
PhD Lunch Seminars Rotterdam
- Speaker(s)
- Michael Gong (Erasmus University Rotterdam)
- Date
- Tuesday, 12 June 2018
- Location
- Rotterdam