hard · Principles of Finance
An investor views a volatility smile in the S&P 500 index option market where the implied volatility of out-of-the-money (OTM) puts is significantly higher than at-the-money (ATM) calls.
This 'skew' most directly contradicts which assumption of the Black-Scholes-Merton model?
- The assumption that the underlying asset price follows a geometric Brownian motion with constant volatility.
- The assumption that the options are European-style and cannot be exercised early.
- The assumption that there are no transaction costs or taxes in the secondary market.
- The assumption that the risk-free rate is known and constant over the life of the option.
Sign up free to see the explanation and track your rank →
More Principles of Finance practice
- Which loan has the higher effective annual rate (EAR)?
- Using the Capital Asset Pricing Model (CAPM), calculate the cost of equity for a firm with
- What is its current market price?
- What is the Multiple of Invested Capital (MOIC) for the equity investors?
- What is its Modified Duration?
- What is the Cash Flow from Operations (CFO)?
- What is the net profit per share for the investor?
- What is its Degree of Financial Leverage (DFL)?