Implied Volatility Functions: Empirical Tests

Bernard Dumas (), Jeff Fleming and Robert E. Whaley

No 5500, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Black and Scholes (1973) implied volatilities tend to be systematically related to the option's exercise price and time to expiration. Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) attribute this behavior to the fact that the Black-Scholes constant volatility assumption is violated in practice. These authors hypothesize that the volatility of the underlying asset's return is a deterministic function of the asset price and time and develop the deterministic volatility function (DVF) option valuation model, which has the potential of fitting the observed cross-section of option prices exactly. Using a sample of S&P 500 index options during the period June 1988 through December 1993, we evaluate the economic significance of the implied deterministic volatility function by examining the predictive and hedging performance of the DV option valuation model. We find that its performance is worse than that of an ad hoc Black-Scholes model with variable implied volatilities.

JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 1996-03
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Published as The Journal of Finance, Vol. L111, no.6, (December 1998), pp. 2059-2106.

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Working Paper: Implied Volatility Functions: Empirical Tests (1996)
Working Paper: Implied Volatility Functions: Empirical Tests (1996)
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