Why is the Index Smile So Steep?
AbstractEmpirical evidence shows that the implied volatility smiles for index options are significantly steeper than those for individual options. We propose a model setup where we start from the joint dynamics of the stocks and where the index value is a weighted sum of individual stock prices. Then the differences between the index smile and the smiles for individual stocks are entirely determined by the dependence structure among the stocks. We illustrate our idea in a jump-diffusion framework where both the diffusion and the jumps are decomposed into common and idiosyncratic components. Empirical data for options on the German stock index DAX and on Deutsche Bank are used to show that the model can explain the stylized facts on implied volatility smiles.
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Bibliographic InfoArticle provided by Springer in its journal Review of Finance.
Volume (Year): 8 (2004)
Issue (Month): 1 ()
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Web page: http://springerlink.metapress.com/link.asp?id=111870
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- Matthias Fengler & Helmut Herwartz & Christian Werner, 2010.
"A dynamic copula approach to recovering the index implied volatility skew,"
University of St. Gallen Department of Economics working paper series 2010
1132, Department of Economics, University of St. Gallen, revised Nov 2011.
- Matthias R. Fengler & Helmut Herwartz & Christian Werner, 2012. "A Dynamic Copula Approach to Recovering the Index Implied Volatility Skew," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 10(3), pages 457-493, June.
- Leonidas Tsiaras, 2010. "Dynamic Models of Exchange Rate Dependence Using Option Prices and Historical Returns," CREATES Research Papers 2010-35, School of Economics and Management, University of Aarhus.
- Félix, Luiz & Kräussl, Roman & Stork, Philip, 2013. "The 2011 European short sale ban on financial stocks: A cure or a curse?," CFS Working Paper Series 2013/17, Center for Financial Studies (CFS).
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