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|Title: ||Of Smiles and Smirks: A Term-Structure Perspective|
|Authors: ||Das, Sanjiv R.|
Sundaram, Rangarajan K.
|Issue Date: ||3-Feb-1998 |
|Series/Report no.: ||FIN-98-024|
|Abstract: ||Empirical anamolies in the Black-Scholes model have been widely
documented in the Finance literature. Pattern in these anamolies (for
instance, the behavior of the volatility smile or of unconditional
returns at different maturities) have also been widely documented.
Theoretical efforts in the literature at addressing these anamolies have
largely centered around extensions of the basic Black-Scholes model. Two
approaches have become especially popular in this context ' introducing
jumps into the return process, and allowing volatility to be stochastic.
This paper employs commonly used versions of these two classes of models
to examine the extent to which the models are theoretically capable of
resolving the observed anamolies. We focus especially on the possible
'term-structures' of skewness, kurtosis, and the implied volatility
smile that can rise under each model. Our central finding is that each
model exhibits moment patterns and implied volatility smiles that are
consistent with some of the observed anamolies, but not with others. In
sum, neither class of models constitutes and adequate explanation of the
empirical evidence, although the stochastic volatility models fair
better than jumps in this regard.|
|Appears in Collections:||Economics Working Papers|
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