Implied Volatility Smiles: Empirical Tests

Posted: 10 Oct 1998

See all articles by Bernard Dumas

Bernard Dumas

INSEAD; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Jeff Fleming

Rice University - Jesse H. Jones Graduate School of Business

Robert E. Whaley

Vanderbilt University - Finance

Abstract

Implied volatility "smiles" have been documented in a number of option markets worldwide. The volatilities implied by the Black-Scholes (1973) model tend to be systematically related to the option's exercise price and time to expiration. Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) offer an explanation for this behavior, that is, the volatility of the return of the underlying asset is a deterministic function of the asset price level and time. Their option valuation methodology, dubbed the "implied binomial tree" approach, describes (perfectly) the observed structure of options prices and purportedly provides more accurate hedge ratios. We systematically evaluate the empirical properties of the implied binomial tree approach to option valuation using S&P 500 index options during the period June 1988 and December 1993.

JEL Classification: G13

Suggested Citation

Dumas, Bernard and Fleming, Jeff and Whaley, Robert E., Implied Volatility Smiles: Empirical Tests. Available at SSRN: https://ssrn.com/abstract=6380

Bernard Dumas

INSEAD ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 60 72 49 92 (Phone)
+33 1 60 72 40 45 (Fax)

HOME PAGE: http://www.insead.fr/~dumas/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Jeff Fleming (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

6100 South Main Street
P.O. Box 1892
Houston, TX 77005-1892
United States
713-348-4677 (Phone)
713-348-5251 (Fax)

HOME PAGE: http://www.ruf.rice.edu/~jfleming

Robert E. Whaley

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-343-7747 (Phone)
615-376-8879 (Fax)

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