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Journal of Financial Econometrics Advance Access originally published online on April 8, 2008
Journal of Financial Econometrics 2008 6(3):361-381; doi:10.1093/jjfinec/nbn004
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© The Author 2008. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

VAR Modeling for Dynamic Loadings Driving Volatility Strings

Ralf Brüggemann
     University of Konstanz

Wolfgang Härdle
     Humboldt-Universität zu Berlin

Julius Mungo
     Humboldt-Universität zu Berlin

Carsten Trenkler
     University of Mannheim

Address correspondence to: Carsten Trenkler, University of Mannheim, Department of Economics, Chair of Empirical Economics, L7, 3-5, D-68131 Mannheim, Germany, or e-mail: trenkler{at}uni-mannheim.de.

JEL Classification: C14, C32


  Abstract

The implied volatility of an option as a function of strike price and time to maturity forms a volatility surface. Traders price according to the dynamics of this high dimensional surface. Recent developments that employ semiparametric models approximate the implied volatility surface (IVS) in a finite dimensional function space, allowing for a low dimensional factor representation of these dynamics. This paper presents an investigation into the stochastic properties of the factor loading time series using the vector autoregressive (VAR) framework and analyzes the dynamic relationship of these factors with economic indicators.

KEYWORDS: implied volatility surface, dynamic semiparametric factor model, vector autoregression, impulse responses

This research was supported by the Deutsche Forschungsgemeinschaft through the SFB 649 ‘Economic Risk’. We thank two anonymous referees and the associate editor for very helpful comments and suggestions.

Received December 22, 2006; revised December 21, 2007; accepted February 27, 2008


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