Smile Dynamics I

Abstract

Traditionally smile models have been assessed according to how well they fit market option prices across strikes and maturities. However, the pricing of most of the recent exotic structures, such as reverse cliquets or Napoleons, is more dependent on the assumptions made for the future dynamics of implied vols than on today’s vanilla option prices. In this article we study examples of some popular classes of models, such as stochastic volatility and Jump/Lévy models, to highlight structural features of their dynamic properties.

JEL Classification: G13