Joint dynamics for the underlying asset and its implied volatility surface: A new methodology for option risk management * †

44 Pages Posted: 9 Jan 2023 Last revised: 22 Jul 2024

See all articles by Pascal Francois

Pascal Francois

HEC Montreal - Department of Finance

Rémi Galarneau-Vincent

HEC Montréal, Students

Geneviève Gauthier

Department of decision Sciences and GERAD; affiliation not provided to SSRN

Frédéric Godin

Concordia University, Quebec - Department of Mathematics & Statistics

Date Written: July 13, 2024

Abstract

This paper develops a dynamic joint model of the implied volatility (IV) surface and its underlying asset which is tractable and seamless to estimate. It combines an asymptotically well-behaved, parametric IV surface representation with a two-component variance, and non-Gaussian asymmetric GARCH specification for the underlying asset returns. Estimated on S&P 500 index return and option data for the 1996-2020 period, the model captures the IV surface movements well and uses them to obtain an improved fit on index returns. It also proves to be an effective risk management tool, producing reliable Value-at-Risk estimates for straddle and strangle positions, and accurate forecasts of the VIX distribution.

Keywords: JEL classification: C22, G13, G17 Implied volatility, Dynamic factor model, Risk management, VIX

JEL Classification: C22, G13, G17

Suggested Citation

Francois, Pascal and Galarneau-Vincent, Rémi and Gauthier, Genevieve and Godin, Frédéric, Joint dynamics for the underlying asset and its implied volatility surface: A new methodology for option risk management * † (July 13, 2024). Available at SSRN: https://ssrn.com/abstract=4319972 or http://dx.doi.org/10.2139/ssrn.4319972

Pascal Francois (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Rémi Galarneau-Vincent

HEC Montréal, Students ( email )

Montreal
Canada

Genevieve Gauthier

Department of decision Sciences and GERAD ( email )

3000 Côte-Sainte-Catherine Road
Montreal, QC H2S1L4
Canada

affiliation not provided to SSRN

Frédéric Godin

Concordia University, Quebec - Department of Mathematics & Statistics ( email )

1455 De Maisonneuve Blvd. W.
Montreal, Quebec H3G 1M8
Canada

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
475
Abstract Views
1,349
Rank
122,085
PlumX Metrics