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Somberlaine
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Joined: December 10th, 2012, 10:36 am

Will Co-Integration Match Volatility?

December 17th, 2012, 8:18 am

Here is a scenario:You have an equity underlier (lets call it X) which you are trading based on a volatility surface. You also have a list of other equity underliers with their own, unique, vol surfaces. Your task is search through that list of other underliers to find the vol surface which is the best match (i.e. the most similar) for X's vol surface. You can do this is one of two ways:1) Run a 4 year, weekly, historical correlation of X against all other underliers and see which of the list are at least 75% correlated or more. From these, pick one which matches X's country of origin or business type. (i.e. try and pick within the list of those which are highly correlated one which is the most similar to X).2) Test for those which are co-integrated with X and pick one of those.I realise that both methods are not great, but this is the situation. Which is the lesser of two evils? Will searching for those which are co-integrated help at all in finding underliers which are a good match for X's vol surface? Thanks.
 
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RDiamond
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Joined: March 5th, 2010, 5:57 pm

Will Co-Integration Match Volatility?

December 20th, 2012, 2:30 am

Why don't you look at correlations of ATM-constant implied volatilities. Options that would represent current ATM vol. will change depending on asset price but Bloomberg shows such implied vol. (at least) for market indices.
 
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Somberlaine
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Joined: December 10th, 2012, 10:36 am

Will Co-Integration Match Volatility?

December 20th, 2012, 11:36 am

Thanks for that suggestion, I'll certainly look in to it. Why would I want to look at ATM-constant implied vol instead of ATM-non-constant implied vol?Why is it important that they are ATM?Thanks,
 
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acastaldo
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Joined: October 11th, 2002, 11:24 pm

Will Co-Integration Match Volatility?

December 20th, 2012, 3:09 pm

What to do you think are the fundamental determinants of a vol surface? I would think it would be properties of the underlying like historical volatility, vol of vol, perhaps skewness of returns, how much of vol comes from diffusion vs jumps, correlation of price and vol if any (so called leverage effect). I would try to roughly match the new underlying to one of the known underlyings based on a few of these properties.