If the volatility of a stock is not constant and changes randomly over time, it generates the implied volatility "smile" or "skew". Which of the following statements about the smile is most valid?
A) The smile arises because changing volatility increases the overall variance of the stock return relative to that assumed by the Black-Scholes formula.
B) The return distribution with stochastic volatility is thinner-tailed than assumed in the Black-Scholes model.
C) The smile arises because changing volatility decreases the overall skewness of the stock return relative to that assumed by the Black-Scholes formula.
D) None of the above.

Question

Quizplus · Accepted Answer

The Answer of If the volatility of a stock is not constant and changes randomly over time, it generates the implied volatility "smile" or "skew". Which of the following statements about the smile is most valid?
A) The smile arises because changing volatility increases the overall variance of the stock return relative to that assumed by the Black-Scholes formula.
B) The return distribution with stochastic volatility is thinner-tailed than assumed in the Black-Scholes model.
C) The smile arises because changing volatility decreases the overall skewness of the stock return relative to that assumed by the Black-Scholes formula.
D) None of the above.

If the Volatility of a Stock Is Not Constant and Changes