Volatility Trading with the Quadratic Normal Model in the Oil Options Market
Paper empirically applies the Quadratic Normal Model for oil options’ pricing and hedging, demonstrating dynamic calibration and risk management benefits.
What it examines
This study explains how to use a new model called the Quadratic Normal Model (QNM) to better price and hedge oil options. It dynamically calibrates model parameters using 25 years of WTI options data, addressing limitations of traditional models by incorporating variance, skewness, and kurtosis to capture market volatility accurately.
What it concludes
The study shows QNM improves pricing and hedging of oil options by capturing volatility nuances. Its dynamic calibration aids digital option pricing and delta-hedging, benefiting risk management and volatility trading. The model is promising for interest rate derivatives and may inform future research in equities, FX, and broader financial markets.
Evidence objects
Researchers recently introduce the Quadratic Normal Model (QNM) that extends the Bachelier framework with parabolic local volatility adjustments capturing variance, skewness, and kurtosis, reducing pricing errors up to seven times.
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Dynamically calibrated across 25 years of WTI option prices, the model reveals market trends where volatility convexity and skew adjust with evolving conditions, while improving digital pricing and delta hedging.
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Employing a novel perturbation method, the study simplifies the analytic pricing formula for rapid valuation, finds promising applications to interest rate options, and notes enduring challenges for equity index options.
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This paper innovatively examines volatility arbitrage in the oil options market through an extension of the Bachelier model using the Quadratic Normal Model. With dynamic calibration capturing skewness and kurtosis over 25 years and application to assets, its original, comprehensive approach delivers significant theoretical and practical contributions to derivative modeling.
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Raw abstract and provenance
- … We also test the model for options on equity index futures and 10-year Treasury Note futures, and obtain some promising initial results, in particular, for the interest rate …
Source row: 2133 · abstract type: snippet