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Sonderforschungsbereich 649: Ökonomisches Risiko, Humboldt-Universität Berlin >
SFB 649 Discussion Papers, HU Berlin >
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http://hdl.handle.net/10419/25039
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| Title: | | A dynamic semiparametric factor model for implied volatility string dynamics  |
| Authors: | | Fengler, Matthias R. Härdle, Wolfgang Karl Mammen, Enno |
| Issue Date: | | 2005 |
| Series/Report no.: | | SFB 649 discussion paper 2005,020 |
| Abstract: | | 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. |
| Subjects: | | smile local volatility generalized additive model backfitting functional principal component analysis |
| JEL: | | C14 G12 |
| Document Type: | | Working Paper |
| Appears in Collections: | | SFB 649 Discussion Papers, HU Berlin
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