Empirical Calibration and Minimum-Variance Delta Under Log-Normal Stochastic Volatility Dynamics

42 Pages Posted: 30 Jan 2014 Last revised: 9 Mar 2016

See all articles by Artur Sepp

Artur Sepp

Sygnum Bank's Asset Management

Date Written: November 17, 2014

Abstract

We consider calibration of log-normal stochastic volatility model and computation of option delta consistently with statistical dynamics of the asset price and its implied volatility surface. We introduce the concept of volatility skew-beta which serves as an empirical adjustment for empirical option delta. We show how to calibrate the model and make it consistent with any dynamics of implied volatility under the statistical measure and reproduce empirical option delta. The calibrated model minimizes realized volatility of delta-hedging P&L-s, especially so for non-vanilla options. We present empirical investigation using implied and realized volatilities of four major stock indices (S&P 500, FTSE 100, Nikkei 225, and STOXX 50) to validate the assumption about log-normality of both implied and realized volatilities.

Keywords: Lognormal stochastic volatility, Jumps in price and volatility, Model calibration, Implied volatility skew, Closed-form solution, Option pricing, Minimum-variance hedging

JEL Classification: C00, G00

Suggested Citation

Sepp, Artur, Empirical Calibration and Minimum-Variance Delta Under Log-Normal Stochastic Volatility Dynamics (November 17, 2014). Available at SSRN: https://ssrn.com/abstract=2387845 or http://dx.doi.org/10.2139/ssrn.2387845

Artur Sepp (Contact Author)

Sygnum Bank's Asset Management ( email )

Uetlibergstrasse 134a
Zurich, 8045
Switzerland

HOME PAGE: http://artursepp.com

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