TY - JOUR
AU - Dumas,Bernard
AU - Fleming,Jeff
AU - Whaley,Robert E.
TI - Implied Volatility Functions: Empirical Tests
JF - National Bureau of Economic Research Working Paper Series
VL - No. 5500
PY - 1996
Y2 - March 1996
DO - 10.3386/w5500
UR - http://www.nber.org/papers/w5500
L1 - http://www.nber.org/papers/w5500.pdf
N1 - Author contact info:
Bernard Dumas
INSEAD
boulevard de Constance
77305 Fontainebleau Cedex
FRANCE
Tel: +33 1 60 72 43 73
Fax: +33 1 60 72 40 50
E-Mail: bernard.dumas@insead.edu
AB - Black and Scholes (1973) implied volatilities tend to be systematically related to the option's exercise price and time to expiration. Derman and Kani (1994), Dupire (1994), and Rubinstein (1994) attribute this behavior to the fact that the Black-Scholes constant volatility assumption is violated in practice. These authors hypothesize that the volatility of the underlying asset's return is a deterministic function of the asset price and time and develop the deterministic volatility function (DVF) option valuation model, which has the potential of fitting the observed cross-section of option prices exactly. Using a sample of S&P 500 index options during the period June 1988 through December 1993, we evaluate the economic significance of the implied deterministic volatility function by examining the predictive and hedging performance of the DV option valuation model. We find that its performance is worse than that of an ad hoc Black-Scholes model with variable implied volatilities.
ER -