Implied basket correlation dynamics

DOI10.1515/STRM-2014-1176MaRDI QIDQ308412zbMATH OpenOpenAlexFDO

Authors Wolfgang K. Härdle, Elena Silyakova

Publication date 6 September 2016

Published in Statistics \& Risk Modeling (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/2009.09770

zbMATH Keywords

dimension reductiondynamic factor modelscorrelation riskdispersion strategy

Mathematics Subject Classification ID

Factor analysis and principal components; correspondence analysis (62H25) Applications of statistics to economics (62P20) Hypothesis testing in multivariate analysis (62H15) Measures of association (correlation, canonical correlation, etc.) (62H20) Statistical methods; risk measures (91G70)

Abstract: Equity basket correlation can be estimated both using the physical measure from stock prices, and also using the risk neutral measure from option prices. The difference between the two estimates motivates a so-called "dispersion strategy. We study the performance of this strategy on the German market and propose several profitability improvement schemes based on implied correlation (IC) forecasts. Modelling IC conceals several challenges. Firstly the number of correlation coefficients would grow with the size of the basket. Secondly, IC is not constant over maturities and strikes. Finally, IC changes over time. We reduce the dimensionality of the problem by assuming equicorrelation. The IC surface (ICS) is then approximated from the implied volatilities of stocks and the implied volatility of the basket. To analyze the dynamics of the ICS we employ a dynamic semiparametric factor model.

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Cited in

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• Basket option pricing and implied correlation in a one-factor Lévy model

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