JMF  Vol.3 No.4 , November 2013
Estimating Realistic Implied Correlation Matrix from Option Prices
Abstract: The purpose of this research is to derive a new algorithm for obtaining a realistic implied correlation matrix. One contemporary method has a limited scope from its simplified assumption of equicorrelation matrix. However, the result of this limitation is not realistic and cannot be applied to most applications. Another existing method may produce the realistic correlation matrix that is not positive-semi definite. To handle this problem, we expand the existing algorithm to obtain the realistic implied correlation matrix by using the relationship between two implied volatilities of the portfolio of underlying assets.
Cite this paper: K. Numpacharoen and N. Numpacharoen, "Estimating Realistic Implied Correlation Matrix from Option Prices," Journal of Mathematical Finance, Vol. 3 No. 4, 2013, pp. 401-406. doi: 10.4236/jmf.2013.34041.

[1]   V. D. Skintzi and A. N. Refenes, “Implied Correlation Index: A New Measure of Diversification,” Journal of Futures Markets, Vol. 25, No. 2, 2005, pp. 171-197.

[2]   J. A. Lopez and C. Walter, “Is Implied Correlation Worth Calculating? Evidence from Foreign Exchange Options and Historical Data,” Journal of Derivatives, Vol. 7, No. 3, 2000, pp. 65-82.

[3]   F. Guillaume, “The αVG Model for Multivariate Asset Pricing: Calibration and Extension,” Review of Derivatives Research, Vol. 16, No. 1, 2013, pp. 25-52.

[4]   A. Busss and G. Vilkov, “Measuring Equity Risk with Option-Implied Correlations,” The Review of Financial Studies, Vol. 25, No. 10, 2011, pp. 3113-3140.

[5]   J. Driessen, P. J. Maenhout and G. Vilkov, “The Price of Correlation Risk: Evidence from Equity Options,” The Journal of Finance, Vol. 64, No. 3, 2009, pp. 1377-1406.

[6]   Chicago Board Options Exchange, “CBOE S&P 500 Implied Correlation Index,” 2009.

[7]   K. Numpachaoren, “Weighted Average Correlation Matrices Method for Correlation Stress Testing and Sensitivity Analysis,” 2012.
http://ssrn com/abstract=2158212

[8]   K. Numpachaoroen and A. Atsawarungruangkit, “Generating Correlation Matrices Based on the Boundaries of Their Coefficients,” PLoS ONE, Vol. 7, No. 11, Article ID: e48902.