Patent ID: 7937313

Claim:
A processor-implemented method for simulating the behavior of a financial instrument, which is an option on an underlying financial instrument, in response to unusual market conditions comprising: providing a volatility surface model representing implied volatility for the option relative to Δ and T values to be used during simulation of the instrument's behavior, the surface model defining a volatility surface using a plurality of surface parameters β 0 , . . . , β n , n≧0, each surface parameter being associated with at least one attribute of the modeled volatility surface, the surface model having a form σ(Δ, T )= F (β 0 , . . . , β n ,Δ,T ) where (i) σ is a measure of the volatility for an option with a given Δ, which is a ratio of a change in option price to a change in security price and T, which is a term remaining for the option and (ii) F is a function of Δ, T and the surface parameters β 0 , . . . , β n ; determining values for surface parameters β 0,normal , . . . , β n,normal under normal market conditions; adjusting at least one of the determined normal surface values β x,normal by a respective stress value β x,stress , 0≦x≦n; generating via a processor a volatility surface based on the provided volatility surface model and a set of the determined normal surface parameter values with the adjustment by the stress value; and extracting a volatility from the generated volatility surface; wherein the plurality of surface parameters comprise at least one surface parameter associated with an offset of the volatility surface relative to the Δ and T axes, at least one surface parameter associated with changes in the volatility surface with respect to the Δ of the option, and at least one surface parameter associated with changes in the volatility surface with respect to the term of the option; wherein the extracted volatility is used in a pricing model to provide a price of the particular instrument.