Accouting for Biases in Black-Scholes

David Backus, Silverio Foresi and Liuren Wu
Additional contact information
Silverio Foresi: Goldman Sachs

Finance from University Library of Munich, Germany

Abstract: Prices of currency options commonly differ from the Black-Scholes formula along two dimensions: implied volatilities vary by strike price (volatility smiles) and maturity (implied volatility of at­the­money options increases, on average, with maturity). We account for both using Gram­Charlier expansions to approximate the conditional distribution of the logarithm of the price of the underlying security. In this setting, volatility is approximately a quadratic function of moneyness, a result we use to infer skewness and kurtosis from volatility smiles. Evidence suggests that both kurtosis in currency prices and biases in Black­Scholes option prices decline with maturity.

Keywords: currency options; skewness and kurtosis; Gram-Charlier expansions; implied volatility (search for similar items in EconPapers)
JEL-codes: C14 F31 G12 G13 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2002-08-30
Note: Type of Document - postscript; prepared on MikTex; to print on postscript; pages: 41 ; figures: included. produced via dvips
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

Downloads: (external link)
https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0207/0207008.pdf (application/pdf)
https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0207/0207008.ps.gz (application/postscript)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0207008

Access Statistics for this paper

More papers in Finance from University Library of Munich, Germany
Bibliographic data for series maintained by EconWPA ( this e-mail address is bad, please contact ).