If the Volatility of a Stock Is Not Constant and Changes

question 12

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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Definitions:

Adjusted Trial Balance

A list of all accounts and their balances after adjusting entries have been made, used to prepare financial statements.

Accrued Salaries

Salaries that have been earned by employees but have not yet been paid by the company, often recorded as a liability on the balance sheet.

Services Paid

Expenses related to services that have been paid for by a company or individual.

Services Performed

Tasks or activities completed by a business in exchange for payment, often recognized as revenue according to the revenue recognition principle.