METHOD AND SYSTEM FOR SIMULATING IMPLIED VOLATILITY SURFACES FOR BASKET OPTION PRICING

A method and system for simulating volatility for basket options is disclosed. A volatility surface model having at least one surface parameter is provided along with a set of volatilities for a plurality of options on the underlying financial instrument. The set of volatilities is analyzed to determine an initial value for each surface parameter which, when used in the surface model, defines a surface approximating the set of volatilities. The values of the surface parameters are then evolved, and a volatility value is extracted from the volatility surface defined by the evolved surface parameter values. The volatility of basket options valued relative to the performance of multiple components can be simulated by determining the value of surface parameters for options on the component securities and then combining the component surface parameters to determine surface parameters for a volatility surface of the basket.