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Does bid-ask spread explains the smile? On DVF and DML

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  • Li, Pengshi
  • Lin, Yan
  • Yu, Xing
  • Liu, Guifang

Abstract

In this paper, we investigate the potential effect of the bid-ask spread on pricing and implied volatilities of the newly established CSI 300 index options in China. We use the deterministic volatility function (DVF) to analyze the pricing errors and employ the double machine learning (DML) technique to evaluate the effect of liquidity costs on implied volatility in the presence of economic confounders. Our research shows that the deterministic volatility function modified to incorporate the bid-ask spread work better than the Black-Scholes model. And a sizable and statistically liquidity costs effect on implied volatility is observed in the CSI 300 options market.

Suggested Citation

  • Li, Pengshi & Lin, Yan & Yu, Xing & Liu, Guifang, 2025. "Does bid-ask spread explains the smile? On DVF and DML," Pacific-Basin Finance Journal, Elsevier, vol. 90(C).
    • Handle: RePEc:eee:pacfin:v:90:y:2025:i:c:s0927538x24003974
    DOI: 10.1016/j.pacfin.2024.102645
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