Arbeitspapier
A dynamic semiparametric factor model for implied volatility string dynamics
A primary goal in modelling the implied volatility surface (IVS) for pricing and hedging aims at reducing complexity. For this purpose one fits the IVS each day and applies a principal component analysis using a functional norm. This approach, however, neglects the degenerated string structure of the implied volatility data and may result in a modelling bias. We propose a dynamic semiparametric factor model (DSFM), which approximates the IVS in a finite dimensional function space. The key feature is that we only fit in the local neighborhood of the design points. Our approach is a combination of methods from functional principal component analysis and backfitting techniques for additive models. The model is found to have an approximate 10% better performance than a sticky moneyness model. Finally, based on the DSFM, we devise a generalized vega-hedging strategy for exotic options that are priced in the local volatility framework. The generalized vega-hedging extends the usual approaches employed in the local volatility framework.
- Language
-
Englisch
- Bibliographic citation
-
Series: SFB 649 Discussion Paper ; No. 2005,020
- Classification
-
Wirtschaft
Semiparametric and Nonparametric Methods: General
Asset Pricing; Trading Volume; Bond Interest Rates
- Subject
-
smile
local volatility
generalized additive model
backfitting
functional principal component analysis
- Event
-
Geistige Schöpfung
- (who)
-
Fengler, Matthias R.
Härdle, Wolfgang Karl
Mammen, Enno
- Event
-
Veröffentlichung
- (who)
-
Humboldt University of Berlin, Collaborative Research Center 649 - Economic Risk
- (where)
-
Berlin
- (when)
-
2005
- Handle
- Last update
-
20.09.2024, 8:25 AM CEST
Data provider
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
Object type
- Arbeitspapier
Associated
- Fengler, Matthias R.
- Härdle, Wolfgang Karl
- Mammen, Enno
- Humboldt University of Berlin, Collaborative Research Center 649 - Economic Risk
Time of origin
- 2005