If the Volatility of a Stock Is Not Constant and Changes

question 26

Multiple Choice

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.

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