Hi EiriamjhThere are some which model directly implied vol:Surface Models I know are Brace et al, Cont et al, Haffner's book.Term-Structure models Schoenbucher, and there is a recent paper by Schweizer/Wissel, I heard of.A problem with the former is that it seems very difficult to ensure that the evolution is arb-free, ie that the call prices are free of arb (butterflies etc) at any future point in time.The term-structure models don't suffer from that drawback, but then you don't know what to do if spot moves far away from the initial strike.Hope that helps. Citi made a presentation on a surface model which they use in risk management.Maybe one of them knows how severe the arb-problem actually is?ByePSOption on fwd variance swap is much easier than an option on implied in some way...it's "just" an option on the difference of two spot started var swaps.(btw this gives you a back-test for prices of fwd start options, since they should give (at least roughly) the fwd var swap)
Last edited by probably
on June 6th, 2005, 10:00 pm, edited 1 time in total.