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Implied volatilities and Transaction Costs

Steve Swidler () and J. David Diltz

Journal of Financial and Quantitative Analysis, 1992, vol. 27, issue 3, 437-447

Abstract: Using data that contain bid and ask quotes for both options and stocks, the analysis investigates the constant volatility assumption of the Black-Scholes model. The analysis adjusts for bid-ask spreads and finds evidence that is inconsistent with the constant volatility assumption. Instead, the results reveal a strong negative correlation between volatility and stock price, and they suggest that using a nonconstant volatility model such as the CEV model would be more appropriate to price long-term options. Finally, transaction costs associated with the dynamic hedge tend to increase with an option's maturity, but decrease as a percentage of the option's price.

Date: 1992
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Handle: RePEc:cup:jfinqa:v:27:y:1992:i:03:p:437-447_00