Review of Derivatives Research

, Volume 20, Issue 2, pp 167–202

Implied volatility and skewness surface

  • Bruno Feunou
  • Jean-Sébastien Fontaine
  • Roméo Tédongap
Article
  • 91 Downloads

Abstract

The Homoscedastic Gamma (HG) model characterizes the distribution of returns by its mean, variance and an independent skewness parameter. The HG model preserves the parsimony and the closed form of the Black–Scholes–Merton (BSM) while introducing the implied volatility (IV) and skewness surface. Varying the skewness parameter of the HG model can restore the symmetry of IV curves. Practitioner’s variants of the HG model improve pricing (in-sample and out-of-sample) and hedging performances relative to practitioners’ BSM models, with as many or less parameters. The pattern of improvements in Delta-Hedged gains across strike prices accord with predictions from the HG model. These results imply that expanding around the Gaussian density does not offer sufficient flexibility to match the skewness implicit in options. Consistent with the model, we also find that conditioning on implied skewness increases the predictive power of the volatility spread for excess returns.

Keywords

SP500 options Implied skewness Implied volatility Volatility spread Delta-hedged gains 

JEL Classification

G12 G13 

Supplementary material

11147_2016_9127_MOESM1_ESM.pdf (102 kb)
Supplementary material 1 (pdf 101 KB)

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Copyright information

© Springer Science+Business Media New York 2017

Authors and Affiliations

  • Bruno Feunou
    • 1
  • Jean-Sébastien Fontaine
    • 1
  • Roméo Tédongap
    • 2
  1. 1.Bank of CanadaOttawaCanada
  2. 2.ESSEC Business SchoolCergy-PontoiseFrance

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