Implied volatility skews and stock return skewness and kurtosis implied by stock option prices

C. J. Corrado and Tie Su

The European Journal of Finance, 1997, vol. 3, issue 1, 73-85

Abstract: The Black-Scholes* option pricing model is commonly applied to value a wide range of option contracts. However, the model often inconsistently prices deep in-the-money and deep out-of-the-money options. Options professionals refer to this well-known phenomenon as a volatility ‘skew’ or ‘smile’. In this paper, we examine an extension of the Black-Scholes model developed by Corrado and Su that suggests skewness and kurtosis in the option-implied distributions of stock returns as the source of volatility skews. Adapting their methodology, we estimate option-implied coefficients of skewness and kurtosis for four actively traded stock options. We find significantly nonnormal skewness and kurtosis in the option-implied distributions of stock returns.

Date: 1997
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DOI: 10.1080/135184797337543

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