|
|
 |
| |
|
|
|
Equity Volatility Smile and Skew under a CEV-based Structural Leverage Model |
|
|
|
PP: 1095-1104 |
|
|
|
Author(s) |
|
|
|
Min Chen,
|
|
|
|
Abstract |
|
|
| The leverage effect is widely considered to be the major contributor to volatility skew in the stock option market. This study
concentrates on explicit modeling of corporate leverage. The asset-equity relation is modeled by a perpetual American option, and the
asymmetry of the asset return distribution is addressed by introducing a Constant Elasticity of Variance (CEV) asset dynamic. The
model retains closed-form representation of firm equity with respect to asset and liability. This provides a convenient simplification to
equity option pricing, so that the model can be calibrated to stock prices and the entire volatility structure. This model demonstrates how
the volatility smile, as well as skew, can be accommodated by the structural model, and also successfully explains why low-leverage
stocks could still have a non-trivial volatility structure. A cross-sectional study shows that the calibrated parameters effectively outline
the financial characteristics of the leveraged firms. The credit quality measure generated from this model is also more informative in
terms of explaining Credit Default Swap (CDS) spread movements. |
|
|
|
|
|
|
|
