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  4. A Dynamic Copula Approach to Recovering the Index Implied Volatility Skew
 
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A Dynamic Copula Approach to Recovering the Index Implied Volatility Skew

Journal
Journal of Financial Econometrics
ISSN
1479-8409
ISSN-Digital
1479-8417
Type
journal article
Date Issued
2012-03
Author(s)
Fengler, Matthias  
Herwartz, H.
Werner, Christian
DOI
10.1093/jjfinec/nbr016
Abstract
Equity index implied volatility functions are known to be excessively skewed in comparison with implied volatility at the single stock level. We study this stylized fact for the case of a major German stock index, the DAX, by recovering index implied volatility from simulating the 30-dimensional return system of all DAX constituents. Option prices are computed after risk neutralization of the multivariate process which is estimated under the physical probability measure. The multivariate models belong to the class of copula asymmetric dynamic conditional correlation models. We show that moderate tail dependence coupled with asymmetric correlation response to negative news is essential to explain the index implied volatility skew. Standard dynamic correlation models with zero tail dependence fail to generate a sufficiently steep implied volatility skew.
Language
English
Keywords
basket Options change of measure copula dynamic conditional correlation Esscher transform multivariate GARCH models
HSG Classification
contribution to scientific community
Refereed
Yes
Publisher
Oxford Journals
Publisher place
Oxford UK
Volume
10
Number
3
Start page
457
End page
493
Pages
37
URL
https://www.alexandria.unisg.ch/handle/20.500.14171/91909
Subject(s)

economics

Division(s)

SEPS - School of Econ...

MS - Faculty of Mathe...

University of St.Gall...

Eprints ID
207330

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