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Collateral Smile

Author

Listed:
  • Markus LEIPPOLD

    (University of Zurich and Swiss Finance Institute)

  • Lujing SU

    (Universtiy of Zurich)

Abstract

We analyze the impact of funding costs and margin requirements on prices of index options traded on the CBOE. We propose a model that gives upper and lower bounds for option prices in the absence of arbitrage in an incomplete market with differential borrowing and lending rates. We show that funding costs and margin requirements cause a substantial increase in option prices, which translates into skew and smile patterns for implied volatility curves even under constant volatilities. Empirical tests show that the slopes our model generates have signi cant statistical power in explaining the slopes observed in the market.

Suggested Citation

  • Markus LEIPPOLD & Lujing SU, 2011. "Collateral Smile," Swiss Finance Institute Research Paper Series 11-51, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1151
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    Cited by:

    1. is not listed on IDEAS
    2. Jensen, Mads Vestergaard & Pedersen, Lasse Heje, 2016. "Early option exercise: Never say never," Journal of Financial Economics, Elsevier, vol. 121(2), pages 278-299.

    More about this item

    Keywords

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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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