easy · FRM Part 2 Market Risk
In the context of the Black–Scholes model, which underlying assumption is directly challenged by the empirical observation of a non-flat volatility smile?
- There are no transaction costs, taxes, or restrictions on short-selling in this idealized, perfectly liquid market.
- The underlying asset does not pay any cash dividends at any time during the option's entire life.
- The risk-free interest rate is assumed to remain constant and perfectly known throughout the life of the option.
- The returns of the underlying asset follow a lognormal distribution with a constant volatility parameter.
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