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A semiparametric factor model for implied volatility surface dynamics

Matthias Fengler, Wolfgang K. Härdle & Enno Mammen

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abstract We propose a semiparametric factor model, which approximates the implied volatility surface (IVS) in a finite dimensional function space. Unlike standard principal component approaches typically used to reduce complexity, our approach is tailored to the degenerated design of IVS data. In particular, we only fit in the local neighborhood of the design points by exploiting the expiry effect present in option data. Using DAX index option data, we estimate the nonparametric components and a low-dimensional time series of latent factors. The modeling approach is completed by studying vector autoregressive models fitted to the latent factors.
   
type journal paper
   
keywords functional principal component Analysis, implied volatility surface, semiparametric factor models
   
language English
kind of paper journal article
date of appearance 1-1-2007
journal Journal of Financial Econometrics
publisher Oxford University Press
ISSN 1479-8409
DOI 10.1093/jjfinec/nbm005
volume of journal 5
number of issue 2
page(s) 189-218
review double-blind review
   
citation Fengler, M., Härdle, W. K., & Mammen, E. (2007). A semiparametric factor model for implied volatility surface dynamics. Journal of Financial Econometrics, 5(2), 189-218, DOI:10.1093/jjfinec/nbm005.