The dynamics of implied volatilities: A common principle components approach
Journal
Review of Derivatives Research
ISSN
1380-6645
ISSN-Digital
1573-7144
Type
journal article
Date Issued
2003-10-01
Author(s)
Abstract
It is common practice to identify the number and sources of shocks that move, e.g., ATM implied volatilities by principal components analysis. This approach, however, is likely to result in a loss of information, since the surface structure of implied volatilities is neglected. In this paper we analyze the implied volatility surface along maturity slices with a common principal components analysis (CPC), known from morphometrics. In CPC analysis, the space spanned by the eigenvectors is identical across groups, whereas variances associated with the common principal components vary. Our analysis shows that implied volatility surface dynamics can be traced back to a common eigenstructure in maturity slices. This empirical result is used to set up a factor model for implied volatility surface dynamics.
Language
English
Keywords
common principal component Analysis
principal component Analysis
factor model
implied volatility surface
smile
HSG Classification
contribution to scientific community
Refereed
Yes
Publisher
Kluwer
Publisher place
Dordrecht [u.a.]
Volume
6
Number
3
Start page
179
End page
202
Pages
24
Subject(s)
Eprints ID
86945