Exploring the Role of the Realized Return Distribution in the Formation of the Implied Volatility Smile

48 Pages Posted: 7 Jun 2017

See all articles by George Chalamandaris

George Chalamandaris

Athens University of Economics and Business - Department of Accounting and Finance

Leonidas Rompolis

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: October 19, 2011

Abstract

This article explores the role of the realized return distribution in the formation of the observed implied volatility smile using the framework of an adaptive expectations model. According to this framework investors update their expectations of future events, through which options are priced, by incorporating information from the underlying asset traded in the spot market. Our study is conducted at the level of cumulants which provide a complete description of investors expectations and can be considered as largely non-parametric with a minimal set of assumptions for the stochastic process that drives asset returns. The empirical results, based on the S&P 500 index, support the significance of the realized distribution in the formation of the implied volatility smile.

Keywords: Filtered historical simulation, Risk-neutral cumulants, Realized cumulants, Adaptive expectations

JEL Classification: G13, G14

Suggested Citation

Chalamandaris, George and Rompolis, Leonidas, Exploring the Role of the Realized Return Distribution in the Formation of the Implied Volatility Smile (October 19, 2011). Journal of Banking and Finance, Vol. 36, No. 4, 2012, Available at SSRN: https://ssrn.com/abstract=2981602

George Chalamandaris

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

Leonidas Rompolis (Contact Author)

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

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