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Explaining the Smile in Currency Options: Is it Anchoring?

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  • Siddiqi, Hammad

Abstract

An anchoring adjusted currency option pricing formula is developed in which the risk of the underlying currency is used as a starting point which gets adjusted upwards to arrive at the currency call risk. Anchoring bias implies that such adjustments are insufficient. The new formula converges to the Garman-Kohlhagen formula in the absence of anchoring bias. Anchoring bias generates the implied volatility smile if investors hold heterogeneous exchange rate expectations.

Suggested Citation

  • Siddiqi, Hammad, 2015. "Explaining the Smile in Currency Options: Is it Anchoring?," MPRA Paper 63528, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:63528
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    References listed on IDEAS

    as
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    7. Nicolas P. B. Bollen & Robert E. Whaley, 2004. "Does Net Buying Pressure Affect the Shape of Implied Volatility Functions?," Journal of Finance, American Finance Association, vol. 59(2), pages 711-753, April.
    8. Siddiqi, Hammad, 2015. "Anchoring Heuristic in Option Pricing," Risk and Sustainable Management Group Working Papers 207677, University of Queensland, School of Economics.
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    13. Siddiqi, Hammad, 2015. "Anchoring Heuristic in Option Pricing," MPRA Paper 63218, University Library of Munich, Germany.
    14. Siddiqi, Hammad, 2009. "Does Coarse Thinking Matter for Option Pricing? Evidence from an Experiment," MPRA Paper 13515, University Library of Munich, Germany.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Anchoring; Implied Volatility; Currency Options; Behavioral Finance;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • 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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