Ad Hoc Black and Scholes Procedures with the Time-to-Maturity

Suk Joon Byun (), Sol Kim and Dong Woo Rhee ()
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Suk Joon Byun: College of Business, Korea Advanced Institute of Science and Technology (KAIST), 85 Hoegi-ro, Dongdaemun-gu, Seoul, 02455, Korea
Sol Kim: College of Business, Hankuk University of Foreign Studies, 107, Imun-ro, Dongdaemun-gu, Seoul, 02450, Korea
Dong Woo Rhee: Credit Guarantee and Investment Facility (CGIF), Asian Development Bank Building, 6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Phlippines

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2018, vol. 21, issue 01, 1-21

Abstract: There are two ad hoc approaches to Black and Scholes model. The “relative smile” approach treats the implied volatility skew as a fixed function of moneyness, whereas the “absolute smile” approach treats it as a function of the strike price. Previous studies reveal that the “absolute smile” approach is superior to the “relative smile” approach as well as to other sophisticated models for pricing options. We find that the time-to-maturity factors improve the pricing and hedging performance of the ad hoc procedures and the superiority of the “absolute smile” approach still holds even after the time-to-maturity is considered.

Keywords: Options; relative approach; absolute approach; ad hoc Black and Scholes model; volatility smile (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1142/S0219091518500066

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