RT Journal Article SR Electronic T1 Extracting Model-Free Volatility from Option Prices JF The Journal of Derivatives FD Institutional Investor Journals SP 35 OP 60 DO 10.3905/jod.2007.681813 VO 14 IS 3 A1 George J. Jiang A1 Yisong S. Tian YR 2007 UL https://pm-research.com/content/14/3/35.abstract AB The CBOE's VIX index is a measure of the implied volatility (IV) in 30-day stock index options. Originally constructed as a weighted average of Black-Scholes IVs from 8 at the money calls and puts, the VIX was redesigned in 2003. The new VIX uses a nonparametric procedure to extract an IV from out of the money calls and puts over the full range of strikes. Implementation of the theoretical procedure, however, requires several approximations, for example to deal with the fact that only a discrete set of strikes are traded in the market, rather than a continuum over the full range from zero to infinity, as required by the theory. In this article, Jiang and Tian look carefully at the new VIX algorithm to assess the impact of these approximations on its accuracy. They find that some of them may produce substantial errors, even in simply recovering the volatility input from a set of options in a pure Black-Scholes world. They then propose a modified calculation technique using a smoothing algorithm, that can almost entirely eliminate the errors.TOPICS: Options, statistical methods, risk management