Estimating Realistic Implied Correlation Matrix from Option Prices

Abstract

The purpose of this research is to derive a new algorithm for obtaining a realistic implied correlation matrix. One contemporary method has a limited scope from its simplified assumption of equicorrelation matrix. However, the result of this limitation is not realistic and cannot be applied to most applications. Another existing method may produce the realistic correlation matrix that is not positive-semi definite. To handle this problem, we expand the existing algorithm to obtain the realistic implied correlation matrix by using the relationship between two implied volatilities of the portfolio of underlying assets.