hard · Quantitative Finance derivatives
A practitioner observes that the 'Volatility Smile' for equity index options is typically downward-sloping (skewed).
Which modeling adjustment is most likely to reproduce this empirical feature?
- Increasing the risk-free interest rate assumed in the option pricing formula.
- Assuming that asset returns follow a symmetric, thin-tailed Normal distribution.
- Using a local volatility model that holds coefficients constant across strikes.
- Introducing a negative correlation between stock returns and volatility shocks.
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