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
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: Suggested Citation