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Options when there's no VolSurf - Emerging/Frontier Markets

Quantitative Finance Asked by Mercadian on October 27, 2021

Context:

Most emerging/frontier markets have no or very thinly traded volatility surfaces for their equity markets (single name and indices alike), furthermore, they usually have restrictions on Short-Selling and Capital Controls

Question:

How would you approach pricing/EoD MtM for simple european calls/puts in this market conditions? I’m interested in the heuristics/thought process, any practical experience and any literature.

What I’ve got so far:

  1. Replication/cost of hedging… hindered by some of the restrictions on short selling
  2. Find a correlated asset that has the desired attributes (liquid spot/Vol and short selling) use this as a proxy
  3. Use the underlying’s historical spot market data:
  • Using simple realized volatility and econometric projections.
  • Deduce a historical distribution single or rolling.

Thx!

M

Tags

One Answer

I think your list covers the approach quite well. What I would add to point 3(i) is that there is a (generally positive) spread of implied vols to realized vols. In this case what might be useful is to combine point 2 with point 3(i) i.e. ascertain the implied/realized spread from the proxy market and apply that to the realized vol obtained from your historical underlying data.

Answered by user35980 on October 27, 2021

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