Collective behavior and options volatility smile: An agent-based explanation

Authored by Wei Zhang, Yi-Fang Liu, Hai-Chuan Xu

Date Published: 2014-04

DOI: 10.1016/j.econmod.2014.03.011

Sponsors: Chinese National Natural Science Foundation Ministry of Education of China

Platforms: No platforms listed

Model Documentation: Other Narrative Flow charts Mathematical description

Model Code URLs: Model code not found

Abstract

This paper represents an initial effect to shed light on the determinants of option implied volatility smile from the micro perspective of traders' behavior. We compare the zero intelligence behavior and the collective behavior with the agent-based simulation. We find that the constant implied volatility, which is the assumption of the Black-Scholes model, can be obtained under the environment of the zero intelligence traders; while the smile shape of implied volatility, which is more consistent with the practical option market worldwide, can be explained by traders' collective behavior. Moreover, different degrees of collective behavior are tested to result that with the increasing of collective degree the implied volatility curve becomes steeper. (C) 2014 Elsevier B.V. All rights reserved.

Tags

Agent-based modeling Artificial financial market Implied volatility smile Option pricing collective behavior