Robust Calculation of Model-Free Implied Volatility from Calibrated Surfaces

Abstract:     
This paper proposes a new method to calculate model-free implied volatility from a calibrated option price surface. This circumvents common interpolation/extrapolation problems found in established methodologies, where prices enter calculation directly, and is numerically more stable. Areas outside the observable strikes are approximated better. Predictive regressions over 180 months based on this new method show that the new method is indeed superior in most cases, even with only very few observable strikes.

Number of Pages in PDF File: 20

Keywords: Option pricing, model-free implied volatility, characteristic functions

JEL Classification: C61, C80, G13

working papers series