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Author: | Derman, E. Kani, I. Zou, J. |
Title: | The local volatility surface: unlocking the information in index option prices |
Journal: | Financial Analysts' Journal
1996 : JUL-AUG, VOL. 52:4, p. 25-36 |
Index terms: | FINANCE INFORMATION OPTION PRICES |
Language: | eng |
Abstract: | As fixed-income investors analyze bond markets using forward rates, so index options investors should analyze volatility markets using local volatilities. In skewed markets, such analysis shows that both the index exposure of standard options and the fair value of many exotic options differ substantially from Black-Scholes predictions. The article explains the concept of local volatility and its use. It also presents three heuristic rules that relate local and implied volatilities. |
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