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Implied volatility skews and stock return skewness and kurtosis implied by stock option prices

  • C. J. Corrado
  • Tie Su
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    The Black-Scholes* option pricing model is commonly applied to value a wide range of option contracts. However, the model often inconsistently prices deep in-the-money and deep out-of-the-money options. Options professionals refer to this well-known phenomenon as a volatility 'skew' or 'smile'. In this paper, we examine an extension of the Black-Scholes model developed by Corrado and Su that suggests skewness and kurtosis in the option-implied distributions of stock returns as the source of volatility skews. Adapting their methodology, we estimate option-implied coefficients of skewness and kurtosis for four actively traded stock options. We find significantly nonnormal skewness and kurtosis in the option-implied distributions of stock returns.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/135184797337543
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    Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

    Volume (Year): 3 (1997)
    Issue (Month): 1 ()
    Pages: 73-85

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    Handle: RePEc:taf:eurjfi:v:3:y:1997:i:1:p:73-85
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    1. Barone-Adesi, Giovanni & Whaley, Robert E., 1986. "The valuation of American call options and the expected ex-dividend stock price decline," Journal of Financial Economics, Elsevier, vol. 17(1), pages 91-111, September.
    2. Charles J. Corrado & Tie Su, 1996. "Skewness And Kurtosis In S&P 500 Index Returns Implied By Option Prices," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 19(2), pages 175-192, 06.
    3. 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 637-54, May-June.
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