Implied Volatility Surface: Construction Methodologies and Characteristics
38 Pages Posted: 10 Jul 2011
Date Written: July 9, 2011
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.
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
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