Estimating European Option Values Without a Volatility Surface

Summary

The document asks how to price and mark simple European calls and puts in emerging or frontier equity markets where volatility surfaces may be absent or thinly traded. It highlights practical constraints that complicate replication and hedging, including short-selling restrictions and capital controls. Suggested starting points include using a correlated, more liquid market as a volatility proxy, estimating realized volatility from the underlying’s historical prices, projecting volatility econometrically, or fitting a historical return distribution.

The response adds that implied volatility has generally traded at a positive spread to realized volatility, and proposes estimating that spread in a proxy market before applying it to realized volatility estimated for the target underlying. This is a heuristic suggestion rather than a tested pricing recipe: the document gives no calibration results, validation, or discussion of how proxy relationships and volatility spreads may change across markets or over time. It leaves practical implementation and model choice open.

Key ideas

• Thin or unavailable volatility surfaces make option valuation difficult in some emerging and frontier markets.
• Short-selling restrictions and capital controls can limit replication and hedging approaches.
• Historical realized volatility and econometric projections are possible inputs when direct implied volatility data are scarce.
• A liquid proxy market may help estimate an implied-to-realized volatility spread for use with the target underlying.
• The proposed methods are heuristics without empirical validation or a complete pricing framework.

Tags

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


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












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:

- Replication/cost of hedging... hindered by some of the restrictions on short selling

- Find a correlated asset that has the desired attributes (liquid spot/Vol and short selling) use this as a proxy

- 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

## Answer by user35980 (score 1, accepted)

https://quant.stackexchange.com/a/55747

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.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.