Understanding complex dynamics in derivatives finance : why do options markets smile?
Johnson, N. F.
Sloot, Peter M. A.
Date of Issue2012
School of Computer Engineering
The origin of the volatility smile phenomenon observed in options markets has eluded the financial world for more than two decades. We provide a new explanation of this phenomenon using a microscopic multi-agent description of markets. In our model individual trading behavior is explicitly included and the prices of the options are determined by demand and supply. Our results reproduce the empirical observations in respect to the shape and dynamic properties of the volatility smile, suggesting that this phenomenon is a natural consequence of traders' heterogeneous behavior and expectations about the future.
Advances in complex systems
© 2012 World Scientific Publishing Company.