1-year real-world projection of equity implied volatility: Modelling and calibration methodology
Document ID: 2011-2066
Published on: 19th January 2011
Author: Steven Morrison
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In this note we have described an approach to real-world projection of equity implied volatility over a 1-year horizon. The modelling approach is based on the SVJD equity model, with option prices (and hence implied volatilities) being derived from assumptions about the real-world distribution of equity returns plus an allowance for volatility and jump risk-premiums. This approach ensures consistency between real-world equity return distributions and implied volatilities and consistency between movements in different points on the implied volatility surface (e.g. absence of arbitrage). We present results of applying this approach to market data on major indices at end-2008 and end-2009.
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