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

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

doi:10.1142/S0219525912500506

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

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

Physics

Research output: Contribution to journal › Article

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 language	English (US)
Article number	1250050
Journal	Advances in Complex Systems
Volume	15
Issue number	7
DOIs	https://doi.org/10.1142/S0219525912500506
State	Published - Oct 1 2012

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Keywords

Microsimulation
Options markets
Volatility smile

ASJC Scopus subject areas

Control and Systems Engineering

Cite this

Qiu, G., Kandhai, D., Johnson, N. F., & Sloot, P. M. A. (2012). Understanding complex dynamics in derivatives finance: Why do options markets smile? Advances in Complex Systems, 15(7), [1250050]. https://doi.org/10.1142/S0219525912500506

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10.1142/S0219525912500506