Image interpolation has a wide range of applications such as frame rate-up conversion and free viewpoint TV. Despite significant progresses, it remains an open challenge especially for image pairs with large displacements. In this paper, we first propose a novel optimization algorithm for motion estimation, which combines the advantages of both global optimization and a local parametric transformation model. We perform optimization over dynamic label sets, which are modified after each iteration using the prior of piecewise consistency to avoid local minima. Then we apply it to an image interpolation framework including occlusion handling and intermediate image interpolation. We validate the performance of our algorithm experimentally, and show that our approach achieves state-of-the-art performance.