Recent evidence suggests that the parameters characterizing the implied volatility surface (IVS) in option prices are unstable. We study whether the resulting predictability patterns may be exploited. In a first stage we model the surface along cross‐sectional moneyness and maturity dimensions. In a second stage we model the dynamics of the first‐stage coefficients. We find that the movements of the S&P 500 IVS are highly predictable. Whereas profitable delta‐hedged positions can be set up under selective trading rules, profits disappear when we increase transaction costs and trade on wide segments of the IVS.
Predictable Dynamics in the S&P 500 Index Options Implied Volatility Surface
GUIDOLIN, MASSIMO;
2006
Abstract
Recent evidence suggests that the parameters characterizing the implied volatility surface (IVS) in option prices are unstable. We study whether the resulting predictability patterns may be exploited. In a first stage we model the surface along cross‐sectional moneyness and maturity dimensions. In a second stage we model the dynamics of the first‐stage coefficients. We find that the movements of the S&P 500 IVS are highly predictable. Whereas profitable delta‐hedged positions can be set up under selective trading rules, profits disappear when we increase transaction costs and trade on wide segments of the IVS.
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