Simulation of Arbitrage-Free Implied Volatility Surfaces

33 Pages Posted: 10 Jan 2023 Last revised: 26 Jun 2023

See all articles by Rama Cont

Rama Cont

University of Oxford

Milena Vuletić

University of Oxford

Date Written: December 11, 2022

Abstract

We present a computationally tractable method for simulating arbitrage-free implied volatility surfaces. We illustrate how our method may be combined with a data-driven model based on historical SPX implied volatility data to generate dynamic scenarios for arbitrage-free implied volatility surfaces. Our approach conciliates static arbitrage constraints with a realistic representation of statistical properties of implied volatility co-movements.

Keywords: Implied volatility, scenario simulation, volatility modeling, risk management, factor models, arbitrage

JEL Classification: G13, G17, C15, C22, C45, C53, C63

Suggested Citation

Cont, Rama and Vuletić, Milena, Simulation of Arbitrage-Free Implied Volatility Surfaces (December 11, 2022). Available at SSRN: https://ssrn.com/abstract=4299363 or http://dx.doi.org/10.2139/ssrn.4299363

Rama Cont

University of Oxford ( email )

Mathematical Institute
Oxford, OX2 6GG
United Kingdom

HOME PAGE: http://www.maths.ox.ac.uk/people/rama.cont

Milena Vuletić (Contact Author)

University of Oxford ( email )

Radcliffe Observatory, Andrew Wiles Building
Woodstock Rd
Oxford, Oxfordshire OX2 6GG
United Kingdom

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