Volatility smile
TheoryDefinition
The pattern that out-of-the-money options trade at higher implied volatilities than at-the-money options. Empirical violation of Black-Scholes (which assumes constant vol).
Equity smiles are typically asymmetric ("smirk" or "skew") — OTM puts pricier than OTM calls because crash risk is asymmetric. FX smiles are more symmetric. Drives sophisticated derivatives pricing models (SABR, Heston).
Equity smiles are typically asymmetric ("smirk" or "skew") — OTM puts pricier than OTM calls because crash risk is asymmetric. FX smiles are more symmetric. Drives sophisticated derivatives pricing models (SABR, Heston).