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Implied volatilities and Transaction Costs

Published online by Cambridge University Press:  06 April 2009

Steve Swidler  and
J. David Diltz
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Abstract

Using data that contain bid and ask quotes for both options and stocks, the analysis investigates the constant volatility assumption of the Black-Scholes model. The analysis adjusts for bid-ask spreads and finds evidence that is inconsistent with the constant volatility assumption. Instead, the results reveal a strong negative correlation between volatility and stock price, and they suggest that using a nonconstant volatility model such as the CEV model would be more appropriate to price long-term options. Finally, transaction costs associated with the dynamic hedge tend to increase with an option's maturity, but decrease as a percentage of the option's price.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 27 , Issue 3 , September 1992 , pp. 437 - 447
Copyright
Copyright © School of Business Administration, University of Washington 1992

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