The Volatility Smile The Black–Scholes–Merton option model was the greatest innovation of 20th century finance, and remains the most widely applied theory in all of finance. Despite this success, the model is fundamentally at odds with the observed behavior of option markets: a graph of implied volatilities against strike will typically display a curve or skew, which practitioners refer to as the smile, and which the model cannot explain. Option valuation is not a solved problem, and the past forty years have witnessed an abundance of new models that try to reconcile theory with markets. The Volatility Smile presents a unified treatment of the Black–Scholes–Merton model and the more advanced models that have replaced it. It is also a book about the principles of financial valuation and how to apply them. Celebrated author and quant Emanuel Derman and Michael B. Miller explain not just the mathematics but the ideas behind the models. By examining the foundations, the implementation, and the pros and cons of various models, and by carefully exploring their derivations and their assumptions, readers will learn not only how to handle the volatility smile but how to evaluate and build their own financial models. Topics covered include: The principles of valuation Static and dynamic replication The Black–Scholes–Merton model Hedging strategies Transaction costs The behavior of the volatility smile Implied distributions Local volatility models Stochastic volatility models Jump–diffusion models The first half of the book, Chapters 1 through 13, can serve as a standalone textbook for a course on option valuation and the Black–Scholes–Merton model, presenting the principles of financial modeling, several derivations of the model, and a detailed discussion of how it is used in practice. The second half focuses on the behavior of the volatility smile, and, in conjunction with the first half, can be used for as the basis for a more advanced course. INDICE: Preface xi .Acknowledgments xiii .About the Authors xv .CHAPTER 1 Overview 1 .CHAPTER 2 The Principle of Replication 13 .CHAPTER 3 Static and Dynamic Replication 37 .CHAPTER 4 Variance Swaps: A Lesson in Replication 57 .CHAPTER 5 The P&L of Hedged Option Strategies in a Black–Scholes–Merton World 85 .CHAPTER 6 The Effect of Discrete Hedging on P&L 105 .CHAPTER 7 The Effect of Transaction Costs on P&L 117 .CHAPTER 8 The Smile: Stylized Facts and Their Interpretation 131 .CHAPTER 9 No–Arbitrage Bounds on the Smile 153 .CHAPTER 10 A Survey of Smile Models 163 .CHAPTER 11 Implied Distributions and Static Replication 175 .CHAPTER 12 Weak Static Replication 203 .CHAPTER 13 The Binomial Model and Its Extensions 227 .CHAPTER 14 Local Volatility Models 249 .CHAPTER 15 Consequences of Local Volatility Models 265 .CHAPTER 16 Local Volatility Models: Hedge Ratios and Exotic Option Values 289 .CHAPTER 17 Some Final Remarks on Local Volatility Models 303 .CHAPTER 18 Patterns of Volatility Change 309 .CHAPTER 19 Introducing Stochastic Volatility Models 319 .CHAPTER 20 Approximate Solutions to Some Stochastic Volatility Models 337 .CHAPTER 21 Stochastic Volatility Models: The Smile for Zero Correlation 353 .CHAPTER 22 Stochastic Volatility Models: The Smile with Mean Reversion and Correlation 369 .CHAPTER 23 Jump–Diffusion Models of the Smile: Introduction 383 .CHAPTER 24 The Full Jump–Diffusion Model 395 .Epilogue 417 .APPENDIX A Some Useful Derivatives of the Black–Scholes–Merton Model 419 .APPENDIX B Backward Ito Integrals 421 .APPENDIX C Variance Swap Piecewise–Linear Replication 431 .Answers to End–of–Chapter Problems 433 .References 497 .Index 501
- ISBN: 978-1-118-95916-9
- Editorial: John Wiley & Sons
- Encuadernacion: Cartoné
- Páginas: 528
- Fecha Publicación: 05/10/2016
- Nº Volúmenes: 1
- Idioma: Inglés