VAR Modeling for Dynamic Semiparametric Factors of Volatility Strings

Abstract

The implied volatility of a European option as a function of strike price and time to maturity forms a volatility surface. Traders price according to the dynamics of this high dimensional surface. Recent developments that employ semiparametric modelsapproximate the implied volatility surface (IVS) in a finite dimensional function space,allowing for a low dimensional factor representation of these dynamics. This paperpresents an investigation into the stochastic properties of the factor loading times seriesusing the vector autoregressive (VAR) framework and analyzes associated movements of these factors with movements in some macroeconomic variables of the Euro-economy.