Industrial Engineering and Management Systems

Korean Institute of Industrial Engineers (대한산업공학회)
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Model Averaging Methods for Estimating Implied and Local Volatility Surfaces

  • Kim, Nam-Hyoung (Department of Industrial and Management Engineering Pohang University of Science and Technology) ;
  • Lee, Jae-Wook (Department of Industrial and Management Engineering Pohang University of Science and Technology) ;
  • Han, Gyu-Sik (Risk Management Team IBK Securities Co., Ltd)
  • Received : 2009.04.15
  • Accepted : 2009.05.27
  • Published : 2009.06.30
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Abstract

In this paper, we review widely used methods to extract local volatility surfaces (LVSs) from implied volatility surfaces (IVSs) and suggest a model averaging method for constructing implied and local volatility surfaces weighted by trading volumes. It makes use of model averaging method by means of bandwidth priors, and then produces a robust LVS estimation. The method is shown to provide the information about the confidence interval of estimators as well as a rather less variable weighted mean value for the IVS and LVS. To show the merits of our proposed method, we conduct simulations on equity-linked warrants (ELWs) with reasonable and acceptable results.

Keywords

References

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