A Novel Method for Arbitrage-Free Option Surface Construction

Forthcoming, Annals of Financial Economics

18 Pages Posted: 30 Jun 2019 Last revised: 26 Aug 2019

Date Written: June 14, 2019

Abstract

In this paper, we provide an alternative framework for constructing an arbitrage-free European-style option surface. The main motivation for our work is that such a construction has rarely been achieved in the literature so far. The novelty of our approach is that we perform the calibration and interpolation in the put option space. To demonstrate the applicability of our technique, we extract the model-free implied volatility from S&P 500 index options. Subsequently, we compare its information content to that of the CBOE VIX index. Our empirical tests indicate that information content of the option-implied volatility values based on our method are superior to the VIX index.

Keywords: Arbitrage-free, European Option, Option Surface, Index option, VIX index

JEL Classification: C58, G13

Suggested Citation

Orosi, Gergely (Greg), A Novel Method for Arbitrage-Free Option Surface Construction (June 14, 2019). Forthcoming, Annals of Financial Economics, Available at SSRN: https://ssrn.com/abstract=3412123 or http://dx.doi.org/10.2139/ssrn.3412123

Gergely (Greg) Orosi (Contact Author)

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