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- Title
Option-implied pdfs, the Black-Scholes model and implied volatility smiles.
- Abstract
The article reports on options implied pdfs. The assumption that asset price levels are lognormally distributed is frequently used in the pricing of option contracts. For example, the Black-Scholes model, a benchmark model for option pricing, is consistent with this assumption. One of the reasons it is a useful benchmark for option pricing is because the logarithmic growth rate of asset prices in the Black-Scholes model is normally distributed. The observed smile for the FTSE 100 is downward sloping and thus deviates from the Black-Scholes flat volatility smile. That is, the implied volatility smile suggests that investors are paying higher premia for contracts with low FTSE 100 strike prices than suggested by the Black-Scholes model.
- Subjects
OPTIONS (Finance); VITAL statistics; FINANCIAL markets; BENCHMARKING (Management); PRICE regulation; FINANCIAL performance
- Publication
Bank of England Quarterly Bulletin, 2004, Vol 44, Issue 4, p450
- ISSN
0005-5166
- Publication type
Article