Re: Grudge Match - The Saga Continues......
totoseow said:
volatilit skew.. cos homoskedasticiity is unrealistic assumption.
jaskin said:
Volatility Smile. By increasing prices for such options, volatility smile could be the markets' indirect way of achieving such higher prices within the framework of the Black-Scholes model. chicken nuggets on me...
The answer is volatility skew. As totoseow pointed out, homoskedasticity is an unrealistic assumption, as with lognormally distributed returns. If the return on most assets are leptokurtic, OTM and ITM options will be more expensive than would be assumed by the Black-Scholes model. But because the returns are not lognormal, the volatilities across board will exhibit a skew than a smile.
Yes, Jason. Chicken nuggets 20 pieces please.
totoseow said:
i kw wat que to ask - stock mkt prices follows random walk or not?
Random walk for sure, even if a trend is established.
Behavioural finance. Which one describes you better?
Prospect Theory, where you place different weights on gains and losses and on different ranges of probability. You are much more distressed by prospective losses than they are happy by equivalent gains. Thus you consider the loss of $1 dollar twice as painful as the pleasure received from a $1 gain. As such you are willing to take more risks to avoid losses than to realize gains. Faced with sure gain, you are risk-averse, but faced with sure loss, you become risk-takers.
or
"Fear of Regret" - you tend to feel sorrow and grief after having made an error in judgement. You avoid selling stocks that have gone down in order to avoid the pain and regret of having made a bad investment. You follow the crowd and conventional wisdom to avoid the possibility of feeling regret in the event that your decisions prove to be incorrect. You find it easier to buy a popular stock and rationalize it going down since everyone else owned it and thought so highly of it.