2007/09/13 by G. Qiu, Qiu, G., D. Kandhai +3
Economics, Econometrics and Finance · Physics and Astronomy · #FOS: Economics and business #FOS: Physical sciences #Physics and Society (physics.soc-ph) #Pricing of Securities (q-fin.PR) #physics.soc-ph #q-fin.PR
paper · pdf · doi:10.48550/arxiv.0709.2070
This paper has been withdrawn by the author(s)
arxiv created 2008/10/30 · arxiv updated 2009/12/01
In this work, we aim to gain a better understanding of the volatility smile observed in options markets through microsimulation (MS). We adopt two types of active traders in our MS model: speculators and arbitrageurs, and call and put options on one underlying asset. Speculators make decisions based on their expectations of the asset price at the option expiration time. Arbitrageurs trade at different arbitrage opportunities such as violation of put-call parity. Difference in liquidity among options is also included. Notwithstanding its simplicity, our model can generate implied volatility (IV) curves similar to empirical observations. Our results suggest that the volatility smile is related to the competing effect of heterogeneous trading behavior and the impact of differential liquidity.