The Dynamics of the S&P 500 Implied Volatility Surface

This empirical study is motivated by the literature on quot;smile-consistentquot; arbitrage pricing with stochastic volatility. We investigate the number and shape of shocks that move implied volatility smiles and surfaces by applying Principal Components Analysis. Two components are identified under a variety of criteria. Subsequently, we develop a quot;Procrustesquot; type rotation in order to interpret the retained components. The results have implications for both option pricing and hedging and for the economics of option pricing