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The implied volatility smirk

The implied volatility smirk This paper provides an industry standard on how to quantify the shape of the implied volatility smirk in the equity index options market. Our local expansion method uses a second-order polynomial to describe the implied volatility–moneyness function and relates the coefficients of the polynomial to the properties of the implied risk-neutral distribution of the equity index return. We present a formal, two-way representation of the link between the level, slope and curvature of the implied volatility smirk and the risk-neutral standard deviation, skewness and excess kurtosis. We then propose a new semi-analytical method to calibrate option-pricing models based on the quantified implied volatility smirk, and investigate the applicability of two option-pricing models. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Quantitative Finance Taylor & Francis

The implied volatility smirk

Quantitative Finance , Volume 8 (3): 22 – Apr 1, 2008
22 pages

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References (62)

Publisher
Taylor & Francis
Copyright
Copyright Taylor & Francis Group, LLC
ISSN
1469-7696
eISSN
1469-7688
DOI
10.1080/14697680601173444
Publisher site
See Article on Publisher Site

Abstract

This paper provides an industry standard on how to quantify the shape of the implied volatility smirk in the equity index options market. Our local expansion method uses a second-order polynomial to describe the implied volatility–moneyness function and relates the coefficients of the polynomial to the properties of the implied risk-neutral distribution of the equity index return. We present a formal, two-way representation of the link between the level, slope and curvature of the implied volatility smirk and the risk-neutral standard deviation, skewness and excess kurtosis. We then propose a new semi-analytical method to calibrate option-pricing models based on the quantified implied volatility smirk, and investigate the applicability of two option-pricing models.

Journal

Quantitative FinanceTaylor & Francis

Published: Apr 1, 2008

Keywords: Option pricing; Implied volatility smirk; Risk-neutral skewness and excess kurtosis; Term structure

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