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What could potentially aggravate implicit volatility 'smile' and 'asymmetry'? - a note

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  • George Jiang

Abstract

This research note shows that the implied Black-Scholes volatility calculated using the bisection algorithm can have significant biases, which are more severe for in-themoney (ITM) options than for out-of-the-money (OTM) options. The biases are shown to have important implications as they could potentially aggravate the well-documented smile or smirk and asymmetry of implied Black-Scholes volatility for equity options. The findings caution the use of bisection algorithm for the calculation of Black-Scholes implied volatility. This research note also shows that the biases can be eliminated using the optimization algorithm which uses at least the first derivative of the objective function.

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  • George Jiang, 2002. "What could potentially aggravate implicit volatility 'smile' and 'asymmetry'? - a note," Applied Economics Letters, Taylor & Francis Journals, vol. 9(2), pages 75-80.
    • Handle: RePEc:taf:apeclt:v:9:y:2002:i:2:p:75-80
    DOI: 10.1080/13504850110052799
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