Implied Volatility Surface: Construction Methodologies and Characteristics

Abstract:     
The implied volatility surface (IVS) is a fundamental building block in computational finance. We provide a survey of methodologies for constructing such surfaces. We also discuss various topics which can influence the successful construction of IVS in practice: arbitrage-free conditions in both strike and time, how to perform extrapolation outside the core region, choice of calibrating functional and selection of numerical optimization algorithms, volatility surface dynamics and asymptotics.

Number of Pages in PDF File: 38

Keywords: volatility surface, dynamics of implied volatility, stochastic volatility models, local stochastic volatility models, calibration, numerical methods, optimization, computational efficiency

JEL Classification: C15, C61, C63, G12, G13

working papers series