The volatility estimation is a crucial problem for pricing derivatives. The traditional implied volatility approach induces the undesired smile effect and is therefore inconsistent with the market reality. A second more realistic approach is due to Bensoussan, Crouhy and Galai (1995) who derive an extension of the Black-Scholes model where the stochastic volatility ? is endogenous and depends on the change in the firm’s financial leverage. These authors give an analytic approximation for ? when the firm is financed by external funds such as debts, under the assumptions that the risk-free rate and the volatility of the return on the firm’s asset are constant. In this work, we will generalize this result by allowing these parameters to be variable.
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Paper provided by Université Libre de Bruxelles, Solvay Brussels School of Economics and Management, Centre Emile Bernheim (CEB) in its series Working Papers CEB with number
04-028.RS.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Jackwerth, Jens Carsten, 1996.
"Generalized Binomial Trees,"
MPRA Paper
11635, University Library of Munich, Germany, revised 12 May 1997.
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