 The Price of a Smile: Hedging and Spanning in Option MarketsAndrea Buraschi () and Jens Jackwerth The Review of Financial Studies, 2001, vol. 14, issue 2, 495-527 Abstract: The volatility smile changed drastically around the crash of 1987, and new option pricing models have been proposed to accommodate that change. Deterministic volatility models allow for more flexible volatility surfaces but refrain from introducing additional risk factors. Thus, options are still redundant securities. Alternatively, stochastic models introduce additional risk factors, and options are then needed for spanning of the pricing kernel. We develop a statistical test based on this difference in spanning. Using daily S&P 500 index options data from 1986-95, our tests suggest that both in- and out-of-the-money options are needed for spanning. The findings are inconsistent with deterministic volatility models but are consistent with stochastic models that incorporate additional priced risk factors, such as stochastic volatility, interest rates, or jumps. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies. Date: 2001 There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it. Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:oup:rfinst:v:14:y:2001:i:2:p:495-527 Ordering information: This journal article can be ordered from Access Statistics for this article The Review of Financial Studies is currently edited by Itay Goldstein More articles in The Review of Financial Studies from Society for Financial Studies Oxford University Press, Journals Department, 2001 Evans Road, Cary, NC 27513 USA.. Contact information at EDIRC. |
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