Smirkness in Economics

Volatility-Smirk

Those who follow developments in the derivatives market, and particularly in its sub-section, the options market, may be aware of the concept of Smirkness. It was first proposed at the 2005 China International Conference in Finance, where professors Jin Zhang and Yi Xiang presented their paper ‘Implied Volatility Smirk’

“In this paper, we propose a new concept of smirkness, which is defined as a triplet of at-the-money implied volatility, skewness (slope at the money) and smileness (curvature at the money) of implied volatility-moneyness curve.”

The paper not only covered ‘The Dynamics of Smirkness’ [page 18] but also laid out ‘The Applications of Smirkness’ [page 19]. For clarification, another publication from professor Jin Zhang – also titled ‘Implied Volatility Smirk’ gives an etymological history of the term :

“After the market crash in 1987, the implied volatility as a function of strike price is skewed towards the left. The phenomenon is regarded as implied volatility smirk.  Smirk = skew + smile

And a third paper from the team, this one called : ‘The Implied Volatility Smirk’ went into even greater detail – and this time provided graphs like the one above which showed : “The flat, skewed and smirked implied volatility functions together with market implied volatilities (shown as dots) on 4 November 2003 for SPX options that mature on 21 November 2003.”

BONUS : Another viewpoint on derivatives : from Philip Coggan writing in his book ‘Paper Promises : Money, Debt and the New World Order’, (Allen Lane, 2011, Hardback, p. 170)

“Banks may have had an ulterior motive for the growth of derivatives. The more complex the product, the harder it was for investors to see the price. The result was fat fees for the banking sector.”






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