Implied Volatility Functions: Empirical Tests / Bernard Dumas, Jeff Fleming, Robert E. Whaley.

Format:

Book

Author/Creator:

Dumas, Bernard.

Contributor:

National Bureau of Economic Research.

Fleming, Jeff, 1964-

Whaley, Robert E. (Robert Edward), 1953-

Series:

Working Paper Series (National Bureau of Economic Research) no. w5500.

NBER working paper series no. w5500

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Implied Volatility Functions

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 1996.

Summary:

Black and Scholes (1973) implied volatilities tend to be systematically related to the option's exercise price and time to expiration. Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) attribute this behavior to the fact that the Black-Scholes constant volatility assumption is violated in practice. These authors hypothesize that the volatility of the underlying asset's return is a deterministic function of the asset price and time and develop the deterministic volatility function (DVF) option valuation model, which has the potential of fitting the observed cross-section of option prices exactly. Using a sample of S&P 500 index options during the period June 1988 through December 1993, we evaluate the economic significance of the implied deterministic volatility function by examining the predictive and hedging performance of the DV option valuation model. We find that its performance is worse than that of an ad hoc Black-Scholes model with variable implied volatilities.

Notes:

Print version record

March 1996.