The Dynamics of Implied Volatilities: A Common Principal Components Approach

Matthias R. Fengler, Wolfgang Härdle & Christophe Villa
It is common practice to identify the number and sources of shocks that move implied volatilities across space and time by applying Principal Components Analysis (PCA) to pooled covariance matrices of changes in implied volatilities. This approach, however, is likely to result in a loss of information, since the surface structure of implied volatilities in the maturities and moneyness dimension is neglected. In this paper we propose to estimate the implied volatility surface at each...
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