In a world increasingly focused on effective enterprise-level risk management, there are notable discrepancies in volatility management techniques. Murex proposes a cross-asset interpolation space with potentially significant risk management impacts
Volatility, as a crucial parameter for derivatives trading, is common to all asset classes. It is not, however, represented consistently, which precludes comprehensive cross-asset volatility transparency and management. As with many things, ‘the devil is in the detail’ and something as seemingly simple as the choice of interpolation method can have a significant impact. Most ‘time interpolations’ in ‘spaces’ such as ‘strike’ or ‘moneyness’ are relatively meaningless as they ignore price dispersion over time implicit in volatility. A commonly used compromise is to adjust moneyness using ‘at-the-money’ volatility (ATMV) interpolated at the square root of time. Using only ATMV ignores, however, the reality of smile. ‘Delta space’ interpolation is consistent through time but is challenged by multiple definitions of delta. Even ignoring this challenge, the computational intensity of translating from smiled delta space back to strike or moneyness space results in less logical but simpler methods prevailing. Other methods, such as interpolating the parameters of a model, for example, SABR, between two dates are satisfactory but are exclusively linked to the given parametric method.
More on Risk Management
ABSTRACT In this paper, we discuss investment allocation to multiple alpha streams that are traded on the same execution platform. This includes when trades are crossed internally, resulting in turnover...
Welcome to The Journal of Investment Strategies' Online First Forum. Here you will find the latest peer reviewed, accepted papers before they are available in print. With Online First publication,...
French bank, JP Morgan and Nomura have all lost senior clearing execs in past month
Welcome to The Journal of Credit Risk's Online First Forum. Here you will find the latest peer reviewed, accepted papers before they are available in print. With Online First publication, users can...
Sign up for Risk.net email alerts
Sponsored video: MarketAxess
Sponsored video: Tradeweb
Multifonds talks to Custody Risk on being nominated for the Post-Trade Technology Vendor of the Year at the Custody Risk Awards 2014
Sponsored webinar: IBM Risk Analytics
There are no comments submitted yet. Do you have an interesting opinion? Then be the first to post a comment.