Understanding complex dynamics in derivatives finance: Why do options markets smile?

G. Qiu, D. Kandhai, N. F. Johnson, P. M.A. Sloot

Research output: Contribution to journalArticle

3 Scopus citations

Abstract

The origin of the volatility smile phenomenon observed in options markets has eluded the financial world for more than two decades. We provide a new explanation of this phenomenon using a microscopic multi-agent description of markets. In our model individual trading behavior is explicitly included and the prices of the options are determined by demand and supply. Our results reproduce the empirical observations in respect to the shape and dynamic properties of the volatility smile, suggesting that this phenomenon is a natural consequence of traders' heterogeneous behavior and expectations about the future.

Original languageEnglish (US)
Article number1250050
JournalAdvances in Complex Systems
Volume15
Issue number7
DOIs
StatePublished - Oct 1 2012

Keywords

  • Microsimulation
  • Options markets
  • Volatility smile

ASJC Scopus subject areas

  • Control and Systems Engineering

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