Market Risk Modeling with Option-Implied Covariances and Score-Driven Dynamics (NAJEF, 2024)
(with Rodrigo Herrera)
Abstract: In this paper we make use of option-implied volatilities to build a time-varying implied correlation matrix. Then, we use this matrix to estimate jointly both the covariance matrix of the returns and the implied covariance matrix dynamics. Finally, we do a backtest and show that the proposed model can effectively use the risk-neutral information to model the variance of the returns and to forecast the Value-at-Risk. Our results show that, in general, the proposed model outperforms the benchmark while considerably reducing the number of parameters to be estimated