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Understanding the Implied Volatility Surface for Options on a Diversified Index

Heath, David; Platen, Eckhard

Description

This paper describes a two-factor model for a diversified index that attempts to explain both the leverage effect and the implied volatility skews that are characteristic of index options. Our formulation is based on an analysis of the growth optimal portfolio and a corresponding random market activity time where the discounted growth optimal portfolio is expressed as a time transformed squared Bessel process of dimension four. It turns out that for this index model an equivalent risk neutral...[Show more]

CollectionsANU Research Publications
Date published: 2004
Type: Journal article
URI: http://hdl.handle.net/1885/81586
Source: Asia-Pacific Financial Markets
DOI: 10.1007/s10690-005-4249-4

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