Collateral Smile

45 Pages Posted: 8 Nov 2011 Last revised: 29 Sep 2014

See all articles by Markus Leippold

Markus Leippold

University of Zurich - Department of Banking and Finance; University of Zurich - Faculty of Economics, Business Administration and Information Technology

Lujing Su

University of Zurich - Department of Banking and Finance

Date Written: September 22, 2014

Abstract

We analyze the impact of funding costs and margin requirements on index options traded on the CBOE. Assuming differential borrowing and lending rates, we derive no-arbitrage bounds for European options. We show that funding costs and the CBOE's margin requirements lead to a price increase, which translates into skew and smile patterns for implied volatility curves even under constant volatilities. Empirical tests confirm that our model-implied slopes have significant statistical power in explaining the slopes observed in the market. Hence, at least in part, funding costs and collateral requirements offer an institutional explanation of the volatility smile phenomenon.

Keywords: collateral requirements, funding costs, volatility smile, option pricing

JEL Classification: G01, G12, G13

Suggested Citation

Leippold, Markus and Su, Lujing, Collateral Smile (September 22, 2014). Swiss Finance Institute Research Paper No. 11-51, Available at SSRN: https://ssrn.com/abstract=1956449 or http://dx.doi.org/10.2139/ssrn.1956449

Markus Leippold (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

University of Zurich - Faculty of Economics, Business Administration and Information Technology ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

Lujing Su

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
427
Abstract Views
2,788
rank
81,313
PlumX Metrics