Assignment 2 Answers - Backus&Zin B40.3176.33 Spring 1999...

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Unformatted text preview: Backus&Zin B40.3176.33 Spring 1999 Assignment 2: Answers April 13, 1999 Eurodollar volatility smile. Implied volatilities are Strike 94.50 94.63 94.75 94.88 95.00 95.13 95.25 95.38 95.50 Call Price na na 0.2225 0.1125 0.0425 0.0225 0.0125 0.0075 0.0075 Call Volatility 0.0847 0.0692 0.0629 0.0833 0.0980 0.1150 0.1417 Put Price 0.0075 0.0150 0.0225 0.0375 0.0925 na na na na Put Volatility 0.1112 0.1041 0.0884 0.0682 0.0687 The volatility smile" below suggests that out-of-the-money options are more valuable than Black-Scholes suggests. Why? One possibility is that big changes are more frequent than the log-normal distribution suggests. Another is that the market, for whatever reason, places more value on these instruments. Eg, equity investors place a high value on out-ofthe-money puts, which protect them against large drops in the market. 15 Implied Volatility (Annual Percentage) 14 13 12 11 10 9 8 7 6 94.5 94.6 94.7 94.8 94.9 95 95.1 Moneyness: X 95.2 95.3 95.4 95.5 ...
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