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Smiles, Bid-Ask Spread and Option PricingJuan Ignacio PeñaUniversidad Carlos III de Madrid - Department of Business Administration Gonzalo RubioUniversidad del País Vasco - Departamento de Fundamentos del Analisis Economico I Gregorio SernaUniversidad Carlos III de Madrid - Department of Business Administration European Financial Management Abstract: Given the evidence provided by Longstaff (1995), and Pena, Rubio and Serna (1999) a serious candidate to explain the pronounced pattern of volatility estimates across exercise prices might be related to liquidity costs. Using all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX-35 index futures from January 1994 to October 1998 we extend previous papers to study the influence of liquidity costs, as proxied by the relative bid-ask spread, on the pricing of options. Surprisingly, alternative parametric option pricing models incorporating the bid-ask spread seem to perform poorly relative to Black-Scholes.
Keywords: Smiles, Bid-Ask Spread, Implied Volatility Function, Option Pricing JEL Classification: G12, G13 Accepted Paper SeriesDate posted: August 22, 2000Suggested CitationContact Information
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