Transaction Costs and the Implied Volatility Smile

Posted: 3 Apr 1997

See all articles by George M. Constantinides

George M. Constantinides

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Date Written: December 1996

Abstract

Proportional transaction costs are considered as a possible explanation of the volatility smile of index options. A tight upper bound on the call option price is derived in the presence of proportional transaction costs by extending stochastic dominance arguments. A tight and novel lower bound on the call option price is derived by imposing a plausible upper bound on the investor's relative risk aversion coefficient. The bounds are sufficiently tight to reject the hypothesis that transaction costs can account for the volatility smile in an otherwise Black-Scholes market environment.

JEL Classification: G13

Suggested Citation

Constantinides, George M., Transaction Costs and the Implied Volatility Smile (December 1996). Available at SSRN: https://ssrn.com/abstract=8274

George M. Constantinides (Contact Author)

University of Chicago - Booth School of Business ( email )

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