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Why do we smile? on the determinants of the implied volatility function

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  • Peña, Juan Ignacio
  • Rubio, Gonzalo
  • Serna, Gregorio

Abstract

We report simple regressions and rather sophisticated linear and nonlinear Granger causality test in order to understand the pattem of implied volatilities across exercise prices. We employ all calls and puts transacted between 16:00 and 16:45 on the Spanish ffiEX-35 index from January 1994 to Apri1 l996. Transaction costs, proxied by the bid-ask spread, seem to be a key determinant of the volatility smile. Moreover, time to expiration, the uncertainty associated with the market and the relative market momentum are also important variables in explaining the smile.

Suggested Citation

  • Peña, Juan Ignacio & Rubio, Gonzalo & Serna, Gregorio, 1997. "Why do we smile? on the determinants of the implied volatility function," DEE - Working Papers. Business Economics. WB 7023, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    • Handle: RePEc:cte:wbrepe:7023
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    References listed on IDEAS

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    1. Bates, David S, 1996. "Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options," The Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 69-107.
    2. Bates, David S, 1991. "The Crash of '87: Was It Expected? The Evidence from Options Markets," Journal of Finance, American Finance Association, vol. 46(3), pages 1009-1044, July.
    3. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    4. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    5. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
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    Cited by:

    1. Pilar Corredor Casado & Rafael Santamaría, "undated". "La estructura temporal de las volatilidades implícitas en la opción sobre el Ibex-35," Studies on the Spanish Economy 04, FEDEA.

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