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Collective behavior and options volatility smile: An agent-based explanation

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  • Liu, Yi-Fang
  • Zhang, Wei
  • Xu, Hai-Chuan

Abstract

This paper represents an initial effect to shed light on the determinants of option implied volatility smile from the micro perspective of traders' behavior. We compare the zero intelligence behavior and the collective behavior with the agent-based simulation. We find that the constant implied volatility, which is the assumption of the Black–Scholes model, can be obtained under the environment of the zero intelligence traders; while the smile shape of implied volatility, which is more consistent with the practical option market worldwide, can be explained by traders' collective behavior. Moreover, different degrees of collective behavior are tested to result that with the increasing of collective degree the implied volatility curve becomes steeper.

Suggested Citation

  • Liu, Yi-Fang & Zhang, Wei & Xu, Hai-Chuan, 2014. "Collective behavior and options volatility smile: An agent-based explanation," Economic Modelling, Elsevier, vol. 39(C), pages 232-239.
    • Handle: RePEc:eee:ecmode:v:39:y:2014:i:c:p:232-239
    DOI: 10.1016/j.econmod.2014.03.011
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