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Analogy Making and the Structure of Implied Volatility Skew

Siddiqi, Hammad (2014): Analogy Making and the Structure of Implied Volatility Skew.

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Abstract

An analogy based call option pricing model is put forward. The model provides a new explanation for the implied volatility skew puzzle and is consistent with empirical findings regarding leverage adjusted option returns. It also explains puzzling superior performance of covered call writing and worse-than-expected performance of zero-beta straddles. The analogy based stochastic volatility and the analogy jump diffusion models are also developed. The analogy based stochastic volatility model generates the skew even without any correlation between the stock price and volatility processes, whereas, the analogy jump diffusion does not require asymmetric jumps to generate the skew.

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