A0477
Title: Common factors in large panels of option prices
Authors: Paolo Santucci de Magistris - LUISS Guido Carli (Italy)
Francesco Violante - IESEG School of Management (France)
Pierluigi Vallarino - Aarhus BSS (Denmark)
Maria Grith - Erasmus University Rotterdam (Netherlands) [presenting]
Abstract: A new factor model is proposed for multivariate tensor-valued data that describes the joint dynamics of a large cross-section of option prices containing over 200 equities of the SPX 500 Index with different strike prices and expiration dates. The factors explain the common variation of all the options in the cross-section, and we model their dynamics in a standard time series context. In contrast, the factor loadings express the heterogeneous response to common shocks and are two-dimensional arrays (i.e., tensors). We propose an inference framework to test the significance of the loadings. Furthermore, we implement a tensor-counterpart version of the multivariate principal component model to deal with the high-parametrization of the factor loadings, which enables us to extract trading signals, which we use to design a dynamic trading strategy. Our results show that this strategy yields significantly higher profits than a mean-variance investment strategy, even when controlling transaction costs.