2017 16th International Symposium on Distributed Computing and Applications to Business, Engineering and Science
Comparison of several implied volatility models
Ying Zhuang
College of Mathematics and Computer Science, Fuzhou
University
Fuzhou, Fujian, China
yingyun0213@163.com
Abstract—The implied volatility is an important parameter
when the trader need to quote the prices of options. The
famous B-S Model assumes that the implied volatility surface
is a constant independent of the option’s strike and time to
maturity. But empirical analysis has proved that implied
volatility surface is a non-flat function. There are several
popular methods to construct the implied volatility surface.
In this paper, the parameter affection and performance of
several models are compared and tested by using empirical
analysis.
Keywords- implied volatility surface, SVI model,
exponential semi-parametric model, Osher model ˈ no-
arbitrage condition
I. INTRODUCTION (HEADING 1)
The volatility of underlying assets is an important
parameter in option pricing. The implied volatility is
calculated from an option pricing model, such as the well-
known Black-Scholes (B-S) pricing Model. B-S Model
assumes that the implied volatility surface is a constant
independent of the option’s strike and time to maturity. But
more and more empirical analysis has proved that implied
volatility surface is a non-flat function with respect to strike
and time to maturity, that is, the implied volatility surface
is curved with smile skew and term structure. So how to
construct the implied volatility surface, that is, construct a
function to fit the surface, becomes a hot topic in
mathematic or finance field.
The methods of constructing an implied volatility (IV)
surface can be classified into two main types: one is using
statistical regression method, such as the parameter model,
non-parametric model and semi-parametric model; the
other is using the methods of the inverse problem to model
implied volatility. In this paper, the influences of
parameters and the performance of several models are
compared and tested by using empirical analysis, including
the deterministic semi-parametric models and the inverse
problem models.
The deterministic volatility models only just simply
consider using a deterministic function to describe the
relationship of the implied volatility with the time to
maturity, strike price or moneyness. Fitting the implied
volatility surface can also be tackled by a semi-parametric
model which is constituted by several parametric functions
for each maturity ߬ in a trading day. The stochastic
2473-3636/17 $31.00 © 2017 IEEE
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DOI 10.1109/DCABES.2017.18
Meiqing Wang
College of Mathematics and Computer Science, Fuzhou
University
Fuzhou, Fujian, China
mqwang@fzu.edu.cn
volatility inspired (SVI) and exponential semi-parametric
(ES) model are common used ones of this sort of method.
The model based on the inverse problem fits the function
by using lots of market data which makes it more feasible
and better forecast performance. The classical model was
proposed by Ronald Lagnado and Stanley Osher (OS).
II. MODELS TO CONSTRUCT IMPLIED VOLATILITY
SURFACES
A. A class of Stochastic Volatility Inspired models
1) SVI model
The stochastic volatility inspired (SVI) was originally
developed at Merrill Lynch in 1999[1]. The SVI’s essence
is by using a hyperbola to represent the implied variance
asymptotically, which meets the Roger Lee’s lemma [2].
The raw parameterization of SVI total implied variance has
the following form:
ଵ
ߪఛ ሺ݇ሻ ൌ ටܽ ൅ ܾሼߩሺ݇ െ ݉ሻ ൅ ඥሺ݇ െ ݉ሻଶ ൅ ܿ ଶ ሽ (1)
ξఛ
௄
where moneyness ݇ ൌ Žሺ ሻ,‫ ܨ‬ൌ ܵ݁ ௥ఛ ,ܵ is the underlying
ி
asset price, ‫ ܭ‬is the strike price of the option, ‫ ݎ‬is the risk-
free interest rate, ߬ is the time to maturity.
2) E-SVI model
Daglish [3] proposed the stationary square root of time
rule, which suggested that the implied volatility was a
௄
function of the combination of the moneyness ݇ ൌ Žሺ ሻ
ி
and the time to maturity߬:
௞
ߪ ൌ ߶ሺ ሻ (2)
ξఛ
According to this rule, Zhuang et al. [4] proposed a Time-
Exponential SVI (E-SVI) model that logarithmic strike
price is replaced with the particular combination of the
logarithmic price and maturity, and also add a new
parameter to adjust the combination.
௞ ௞
ߪఛ ሺ݇ሻ ൌ ඨܽ ൅ ܾ ቊߩ ቀ െ ݉ቁ ൅ ටሺ െ ݉ሻଶ ൅ ܿ ଶ ቋ (3)
ఛഁ ఛഁ
B. Semi-Parametric Model
1) Exponential Semi-Parametric Model(ES)
In 1998, Dumas et al. [5] proposed a deterministic
parameterization model in which implied volatilities are
described as a quadratic function depending on maturity
and strike price. Cassese and Guidolin [6] then found that
MIBO (written on the MIB30, the most important Italian
stock index) implied volatility surface has a rich structure
which inspired them to develop a host of alternative
reduced form models of implied volatility.
ߪሺ݇ǡ ߬ሻ ൌ ߚ଴ ൅ ߚଵ ݇ ൅ ߚଶ ݇ ଶ ൅ ߚଷ ߬ ൅ ߚସ ሺ݇ ‫߬ כ‬ሻ ൅ ߝ (4)
಼
௟௡ሺ ሻ
with moneyness ݇ ൌ ಷ
ξఛ
Borovkova and Permana [7] considered that the shapes of
the implied volatilities vary with different time-to-
maturities and may not be captured by a surface accurately.
So, when fixing the time-to-maturity, the implied volatility
can be considered as a function of the moneyness which is
a semi-parametric model:
ߪఛ ሺ݇ሻ ൌ ߚ଴ ൅ ߚଵ ݇ ൅ ߚଶ ݇ ଶ ൅ ߝ (5)
2) Gaussian Semi-parametric model(GS)
As the ES model modeling the implied volatility with a
polynomial or fractional order polynomial, the highest
degree with the moneyness is an important factor to
influence the curvature. In order to obtain a continuous and
differentiable smooth function to fit implied volatility, Wu
et al. proposed ta Gaussian semi-parametric model in which
the Gaussian function is used to construct a new function
to substitute the quadratic term of moneyness in ES model
[8]
: For the SVI and ES models, when fix the maturity, using
ଵ ି
ߪఛ ሺ݇ሻ ൌ ߚ଴ ൅ ߚଵ ሺ݇ െ ߚଶ ሻ ൅ ߚଷ ሾ݉ܽ‫ ݔ‬൭
ఉర ξଶగ
ሺೖషഁమ ሻమ
ଵ ି
݁ మഁర
మ
ሿ ఉఱ
ఏξଶగ
C. Option Inverse problem model
1) Osher model˄OS˅
In 1998, Ronald Lagnado and Stanley Osher [9] proposed
that if the implied volatility of a new option is used to
calculate the option price, then the price must be between
the ask price and bid price.
ܸ௜௝௕ ൑ ܸሺܵ଴ ǡ ͲǢ ‫ܭ‬௜௝ ǡ ߬௜ ǡ ɐሻ ൑ ܸ௜௝௔
௔ ௕
where ܸ௜௝ is ask price, ܸ௜௝ is the bid price,ܵ଴ is the
underlying asset price at initial time.
In this way, an energy functional concerning implied
volatility can be generated, and the problem of solving the
implied volatility function is transformed into the problem
of calculating the extremum of the energy functional.
ெ೔
‫ܧ‬ሺߪሻ ൌ σே ത ଶ
௜ୀଵ σ௝ୀଵሾܸ൫ܵ଴ ǡ ͲǢ ‫ܭ‬௜௝ ǡ ܶ௜ ǡ ɐ൯ െ ܸ௜௝ ሿ
ଵ
ത ௔ ௕
where ܸ௜௝ ൌ ሺܸ௜௝ ൅ ܸ௜௝ ሻ is the arithmetic mean of the ask
ଶ
and bid price.
2) K-Weight Osher model(KO)
In 2000, Chiarella [10] expanded the model of the Osher
model, using the implied volatility of an existence time to
represent the implied volatility of the option. Du [11]
proposed a new model with inverse problem based on the
Osher model and the Chiarella model, which add the
weights related to the strike price. The weights describe the
importance of the option prices with different strike prices
to the implied volatility with a given strike. The longer
distance between two strike prices implies less importance.
The model is described as follows:
‫ܧ‬ሺߪ௄ ሻ ൌ σே
ெ೔ ஶ ்೎ೠೝ
ሾܸ൫ܵ଴ ǡ ͲǢ ‫ܭ‬௜௝ ǡ ܶ௜ ǡ ɐ൯ െ ܸത௜௝ ሿଶ ݀ܵ݀‫( ݐ‬9)
௜ୀଵ σ௝ୀଵ ߙ௄ ‫׬‬଴ ‫׬‬଴
III. INFLUENCES OF PARAMETERS OF ABOVE MODELS
The SVI and ES models are the semi-parametric models
which come with certain advantages. We first analyze the
influence of parameters on every model. Two methods are
used to analyze the influences of the parameters. The first
one is to calculate the partial derivative of every parameter
to find the change trends and directions of IV smiles. The
second one is to change the value of a parameter when
fixing other parameters to compare the function image.
The influence of the parameters of the models are
displayed on Table 1 and demonstrated in Fig.1. Table 1
listed the movements of IV smile controlled by the
parameters of two models. Fig.1 demonstrated translations
of IV smile. Vertical direction translation is moving the IV
smile upwards or downwards. Horizontal direction
translation is translating the IV smile to the left or right.
Increasing left and right-wing slops will tighten the smile.
And increasing left wing slops and decreasing right wing
slops will rotate the smile in counter-clockwise direction.
IV. COMPARISON OF ERRORS
ሺೖషഁమ ሻమ
మ the time-dependent parameters to fit the market data can be
݁ మഁర ൱െ obtained several curves to fit the smile in a trading date. We
may find that the different curves have line crossing while
൅ߝ (6) there has point of intersection. Obviously, no arbitrage is
equivalent to no lines crossing as we use the time-
dependent parameters for each model [12].
In fact, Roper had proved that time-dependent implied
volatility parameterized function is free of arbitrage if and
only if the total implied variance function meets the
Durrleman’s Condition [13]:
߱ఛ ሺ݇ሻ ൌ ߪఛ ሺ݇ሻଶ ߬ (10)
ሺƒሻ‫ ߬׊‬൐ Ͳǡ ߥሺήǡ ߬ሻ‹•–™‹ ‡†‹ˆˆ‡”‡–‹ƒ„Ž‡Ǣ
(7) ‫ۓ‬ሺ„ሻ‫݇׊‬
‫ א‬Թǡ ƒ†߬ ൐ Ͳǡ ߱ሺ݇ǡ ߬ሻ ൐ ͲǢ
ۖ
ۖሺ ሻ‫ א ݇׊‬Թǡ ߬ ൐ Ͳǡ
௞డ ఠሺ௞ǡఛሻ ଶ
ೖ డమ ఠሺ௞ǡఛሻ ଵ ଵ డ ఠሺ௞ǡఛሻ
‫݃۔‬ሺ݇ሻ ൌ ቀͳ െ ଶఠሺ௞ǡఛሻ ቁ ൅
ೖ
ቀ ൅ ቁ െ ೖೖ ൒ Ͳ
ସ ఠሺ௞ǡఛሻ ସ ଶ
ۖሺ†ሻ‫ א ݇׊‬Թǡ ߱ሺ݇ǡήሻ‹•‘Ǧ†‡ ”‡ƒ•‹‰ǡ ߲ ߱ሺ݇ǡ ߬ሻ ൒ ͲǢ
ۖ ఛ
‫ە‬ሺ‡ሻ‫ א ݇׊‬Թǡ ߱ሺ݇ǡ Ͳሻ ൌ ͲǤ
(11)
The implied volatility surface under condition (d) could
(8) be guaranteed to be free of calendar spread arbitrage.
For every model, it can generate one slice of the implied
volatility surface and the ݃ሺ݇ሻ for the fixed maturity. It can
be tested that the implied volatility surfaces are absence of
butterfly arbitrage when they consist with the condition (c).
Fig.2 shows the total implied variance of AAPL call
options on March 1, 2016 for different time-to-maturities.
For all moneynesses, the total implied variance decreases
with respect to maturity which meet the condition (c).
V. PREPARE YOUR PAPER BEFORE STYLING
In this section, the performance of above models are
tested by using empirical analysis. The analyzed data is the
data on the trading of options on the AAPL taken from the
Nasdaq Market from Mar. 1st to Mar. 31st.
We complete two groups of experiments. Firstly, the
fitting implied volatility is calculated by every model with
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real data to compare the root mean squared estimation error
and the mean absolute estimation error. Secondly, we try to
use the experimental data to compute the option price for
comparing with the market data. The results of these
experiments are listed on Table2.
ଵ REFERENCES
‫ܧۓ‬ோெௌ഑ ൌ ට σ௡௜ୀଵሺߪො െ ߪሻଶ Ǣ
௡ [1] Gatheral J., A parsimonious arbitrage-free implied volatility
ۖ parameterization with application to the valuation of volatility
ۖ‫ܧ‬ ଵ ௡
ெ஺഑  ൌ σ௜ୀଵȁߪ
ො െ ߪȁ Ǣ
௡ derivatives, Presentation at Global Derivatives,2004.
(12)
‫۔‬ ଵ ଶ
‫ܧ‬ோெௌ಴ ൌ ට σ௡௜ୀଵ൫‫ܥ‬መ െ ‫ܥ‬൯
ۖ ௡
ۖ ଵ ௡
‫ܧە‬ெ஺಴ ൌ ௡ σ௜ୀଵห‫ܥ‬መ െ ‫ܥ‬ห Ǥ
where ߪ,‫ ܥ‬are the market data of implied volatility and
option price, ߪො,‫ܥ‬መ are the corresponding estimated value.
VI. CONCLUSION
Using statistical regression method and solving option
inverse problem method are the two main types to
constructing an implied volatility surface. And on these
bases three new models are put forward: the Time-
Exponential SVI model (E-SVI), the Gaussian semi-
parametric model (GS), and K-Weight Osher model (KO).
In the E-SVI model, the logarithmic strike price is replaced
with the particular combination of the logarithmic price and
maturity in the SVI model, and also add a new parameter to
adjust the combination. In the GS model, the Gaussian
function is used to construct a smooth function substituting
the quadratic term in the Borovkova’s model. KO model is
an improved model with inverse problem based on the
Osher model and the Chiarella model, which add the
weights based on the strike price. It also carries some
empirical analyses based on AAPL stock option. The
experimental results show that E-SVI model is more
flexible and accurate then SVI model. Compare with ES and
GS model, the GS model can obtain a good performance in
fitting. Finally, the KO model is better feasibility and
accuracy then OS model in the market data.
ACKNOWLEDGMENT
This work was supported by Natural Science
Foundation of Fujian (China) under Grant No. 2015J01013
[2] Lee R W. The moment formula for implied volatility at extreme
strikes[J]. Mathematical Finance, 2004, 14(3): 469-480.
[3] Daglish T, Hull J, Suo W. Volatility surfaces: theory, rules of thumb,
and empirical evidence[J]. Quantitative Finance, 2007, 7(5):507-
524.
[4] Ying Z, Wu X, Wang M. Time Index Extension of the SVI Implied
Volatility model[J]. Journal of Fuzhou university (Natural Science
Edition). In press.
[5] Dumas B, Fleming J, Whaley R E. Implied Volatility Functions:
Empirical Tests[J]. The Journal of Finance, 1998, 53(6):2059-2106.
[6] Cassesse G, Guidolin M. Modelling the MIB30 implied volatility
surface. Does market efficiency matter? [J]. Working Papers,
2005(No. 2005-008).
[7] Borovkova S and Permana FJ. Implied volatility in oil markets.
Computational Statistics & Data Analysis, 53(6), 2009, 2022-2039.
[8] Wu X, Zhuang Y, Chen F, et al. A Gaussian semi-parametric implied
volatility model[J]. Journal of Algorithms & Computational
Technology, 2017:174830181770960.
[9] R. Lagnado, S. Osher (1991). A technique for calibrating derivative
security pricing models: numerical solution of an inverse problem.
Journal of computational finance. Vol.1, No.1: 13-25.
[10] C. Chiarella, M. Craddock, N. El-Hassan (2000). The calibration of
stock option pricing models using inverse problem methodology.
QFRQ Research Papers. UTS Sydney.
[11] Du B.A strike-related implied volatility model based on the inverse
problem[D]. Fuzhou university, 2017.
[12] Gatheral J, Jacquier A. Arbitrage-free SVI volatility surfaces[J].
Quantitative Finance, 2012, 14(1):59-71.
[13] Roper M. Arbitrage free implied volatility surfaces[J]. preprint,
2010.

ķ Vertical direction translation

1.2
ĸ Horizontal direction translation

1
Implied volatility

Ĺ left wing slops Ļ right wing slops

0.8 increases increases

0.6
Ľ ATM curvature reduces

0.4
ĺ left wing slops ļ right wing slops
decreases decreases
0.2

0
-1 -0.5 0 0.5 1
moneyness k

Fig. 1. The influences of parameters

ķ Vertical direction translation: Move the IV smile upwards or downwards
ĸ Horizontal direction translation: Translate the IV smile to the left or right;
Ĺ left wing slops increases+Ļ right wing slops increases: Tighten the smile;
Ĺ left wing slops increases+ļ right wing slops decreases: Rotate the smile in counter-clockwise direction.

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 TABLE 1
INFLUENCES OF PARAMETERS
SVI E-SVI ES GS
Translation parameter’s parameter’s parameter’s parameter’s
parameter parameter parameter parameter
change change change change
Vertical ܽ increasing ܽ increasing ߚ଴ increasing ߚ଴ increasing
translation ܽincreases the ܽ increases the ߚ଴ increases ߚ଴ increases the
of the smile general level general level the general general level of
of the smile of the smile level of the the smile
smile
Horizontal ݉ increasing ݉ ݉ increasing ݉ -- -- ߚଶ increasing
translation translates the translates the ߚଶ translates
of the smile smile to the smile to the the smile to the
right right right
ATM ߪ increasing ߪ ߪ increasing ߪ -- ߚହ increasing
curvature reduces the reduces the ߚହ reduces the
translation ATM ATM ATM curvature
of the smile curvature of curvature of
smile smile
translation ߩ;ܾ decreasing ߩ ߩ;ܾ; ߚ decreasing ߩ, ߚଵ; ߚଶ decreasing ߚଵ ߚଵ;ߚଷ ;ߚସ decreasing ߚଵ ,
of the slope or increasing ߚor increasing or increasing ߚସ or
of left wing ܾ increase the ܾ increase the ߚଶ increase the increasing
slope of the slope of the slope of the left ߚଷincrease the
left wing left wing wing slope of the left
wing
translation ߩ;ܾ increasing ߩ or ߩ;ܾ;ߚ increasing ߩ, ߚଵ; ߚଶ increasing ߚଵ ߚଵ;ߚଷ ;ߚସ increasing ߚଵ ,
of the slope ܾ increase the ߚor ܾ increase or ߚଶ increase ߚଷor decreasing
of right wing slope of the the slope of the the slope of the ߚସ increase the
left wing left wing left wing slope of the left
wing
The total implied variance

moneyness k
Fig. 2. Total implied variance plot for AAPL call option data on March 1, 2016 (matu. =time-to-
maturity)

TABLE 2
COMPARISON OF MODEL DATA WITH THE MARKET IMPLIED VOLATILITY AND OPTION PRICE
model ࡱࡾࡹࡿ࣌ ࡱࡹ࡭࣌ ࡱࡾࡹࡿ࡯ ࡱࡹ࡭࡯
SVI 0.0265 0.0308 0.0822 0.4872
E-SVI 0.0126 0.0296 0.0278 0.4006
ES 0.0438 0.0410 0.2066 0.5209
GS 0.0403 0.0312 0.1019 0.4775
OS 0.1214 0.1095 1.4060 0.8632
KO 0.0940 0.0467 0.9027 0.4975

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