Important Notice: Our web hosting provider recently started charging us for additional visits, which was unexpected. In response, we're seeking donations. Depending on the situation, we may explore different monetization options for our Community and Expert Contributors. It's crucial to provide more returns for their expertise and offer more Expert Validated Answers or AI Validated Answers. Learn more about our hosting issue here.

What is the approach taken to volatility smile modelling?

0
Posted

What is the approach taken to volatility smile modelling?

0

Deeply in-the-money and deeply out-of-the-money options are generally under priced, and at-the-money options over priced by the Black-Scholes model and other related models like the binomial model. When these models are used the volatility parameter is “jacked up” (or down) to get the results observed in the market. The adjusted volatility, in effect, becomes a calibration factor rather than a representation of the “true volatility” of the underlying asset. The presence of a volatility smile may imply a non-lognormal distribution rather than a volatility which somehow varies by strike. For example a distribution with fat tails (excess kurtosis) implies that extreme returns occur more frequently than would be predicted by a normal distribution of asset returns. A number of attempts have been made to model this. One approach, implemented in the the Historic Volatility Calculator is based on using a non-lognormal probability distribution taking into account estimates of skewness (symmetry

Related Questions

Thanksgiving questions

*Sadly, we had to bring back ads too. Hopefully more targeted.