Option-Implied Information: What's the Vol Surface Got to Do With It?
32 Pages Posted: 11 Jun 2018 Last revised: 25 Jan 2019
Date Written: November 14, 2018
We find that option-implied information such as forward-looking variance, skewness and the variance risk premium are sensitive to the way the volatility surface is constructed. For some state-of-the-art volatility surfaces, the differences are economically surprisingly large and lead to systematic biases, especially for out-of-the-money put options. To overcome this problem we propose a volatility surface that is built with a one-dimensional kernel regression. We assess its statistical accuracy relative to existing state-of-the-art parametric, semi- and non-parametric volatility surfaces by means of leave-one-out cross-validation. Based on 14 years of end-of-day and intraday S&P 500 and Euro Stoxx 50 option data we conclude that the proposed one-dimensional kernel regression represents option market information more accurately than existing approaches of the literature.
Keywords: option-implied, risk-neutral variance, risk-neutral density, tail risk, option standardization, interpolation, performance measurement
JEL Classification: G13, G17, C14
Suggested Citation: Suggested Citation