Why do we smile? On the determinants of the implied volatility function

We report simple regressions and Granger causality tests in order to understand the pattern of implied volatilities across exercise prices. We employ all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX-35 index from January 1994 to April 1996. Transaction costs, proxied by the...

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Bibliographic Details
Published in:Journal of banking & finance 1999-08, Vol.23 (8), p.1151-1179
Main Authors: Peña, Ignacio, Rubio, Gonzalo, Serna, Gregorio
Format: Article
Language:English
Subjects:
Asked price
Bids
Bid–ask spread
Causality
Regression analysis
Smiles
Spread
Studies
Volatility
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Summary:We report simple regressions and Granger causality tests in order to understand the pattern of implied volatilities across exercise prices. We employ all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX-35 index from January 1994 to April 1996. Transaction costs, proxied by the bid–ask spread, seem to be a key determinant of the curvature of the volatility smile. Moreover, time to expiration, the uncertainty associated with the market and the relative market momentum are also important variables in explaining the smile.
ISSN:0378-4266
1872-6372
DOI:10.1016/S0378-4266(98)00134-4