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Smiles, Bid‐ask Spreads and Option Pricing

Author

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  • Ignacio Peña
  • Gonzalo Rubio
  • Gregorio Serna

Abstract

Given the evidence provided by Longstaff (1995), and Peña, Rubio and Serna (1999) a serious candidate to explain the pronounced pattern of volatility estimates across exercise prices might be related to liquidity costs. Using all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX‐35 index futures from January 1994 to October 1998 we extend previous papers to study the influence of liquidity costs, as proxied by the relative bid‐ask spread, on the pricing of options. Surprisingly, alternative parametric option pricing models incorporating the bid‐ask spread seem to perform poorly relative to Black‐Scholes.

Suggested Citation

  • Ignacio Peña & Gonzalo Rubio & Gregorio Serna, 2001. "Smiles, Bid‐ask Spreads and Option Pricing," European Financial Management, European Financial Management Association, vol. 7(3), pages 351-374, September.
    • Handle: RePEc:bla:eufman:v:7:y:2001:i:3:p:351-374
    DOI: 10.1111/1468-036X.00160
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    Cited by:

    1. Rubio Irigoyen, Gonzalo & Ferreira García, María Eva & Gago, Mónica & León, Angel, 2002. "An empirical comparison of the performance of alternative option pricing models," DFAEII Working Papers 1988-088X, University of the Basque Country - Department of Foundations of Economic Analysis II.
    2. Li, Pengshi & Xian, Aichuan & Lin, Yan, 2021. "What determines volatility smile in China?," Economic Modelling, Elsevier, vol. 96(C), pages 326-335.
    3. Energy Sonono, Masimba & Phillip Mashele, Hopolang, 2016. "Estimation of bid-ask prices for options on LIBOR based instruments," Finance Research Letters, Elsevier, vol. 19(C), pages 33-41.
    4. Panayiotis Andreou & Chris Charalambous & Spiros Martzoukos, 2014. "Assessing the performance of symmetric and asymmetric implied volatility functions," Review of Quantitative Finance and Accounting, Springer, vol. 42(3), pages 373-397, April.

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