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Durham University

Research & business

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Publication details for Professor Panayiotis Andreou

Andreou, P.C. , Charalambous, C. & Martzoukos,S. (2014). Assessing the performance of symmetric and assymetric implied volatility functions. Review of Quantitative Finance and Accounting 42(3): 373-397

Author(s) from Durham

Abstract

This study examines several alternative symmetric and asymmetric model specifications of regression-based deterministic volatility models to identify the one that best characterizes the implied volatility functions of S&P 500 Index options in the period 1996–2009. We find that estimating the models with nonlinear least squares, instead of ordinary least squares, always results in lower pricing errors in both in- and out-of-sample comparisons. In-sample, asymmetric models of the moneyness ratio estimated separately on calls and puts provide the overall best performance. However, separating calls from puts violates the put-call-parity and leads to severe model mis-specification problems. Out-of-sample, symmetric models that use the logarithmic transformation of the strike price are the overall best ones. The lowest out-of-sample pricing errors are observed when implied volatility models are estimated consistently to the put-call-parity using the joint data set of out-of-the-money options. The out-of-sample pricing performance of the overall best model is shown to be resilient to extreme market conditions and compares quite favorably with continuous-time option pricing models that admit stochastic volatility and random jump risk factors.