Equity correlations implied by index options: estimation and model uncertainty analysis (Q2847242)

In this substantive article, the authors present a no-arbitrage multi-asset derivative pricing model. The methodology is related to a well-posed convex optimisation problem. A calibration algorithm is produced; following this, multi-asset options are priced in association with observed index option prices using a Monte Carlo scheme. This flexible approach prices options consistently and also improves upon the existing diffusion models with constant correlation. In addition, it is possible for the model uncertainty to be quantified.NEWLINENEWLINEIn an attempt to incorporate the implied volatility smile, the authors use the two multi-asset models CEV and jump-diffusion as their starting point.NEWLINENEWLINEThe article finishes with an illustration of an application of the method to the DJIA index option prices. In particular, it considers the correlation uncertainty impact on some equity options.