Stochastic Volatility Models Are Said to Incorporate the "Leverage" Effect

question 16

Multiple Choice

Stochastic volatility models are said to incorporate the "leverage" effect. The presence of the leverage effect

• A) Results in a left skew in the options smile because stock price drops are associated with higher firm leverage and so with increased volatility.
• B) Results in a right skew in the options smile because stock price increases are associated with higher firm leverage and so with increased volatility.
• C) Results in a symmetric distribution of stock returns, resulting in higher option prices both in- and out-of-the-money.
• D) All option models have a leverage effect because the option is a leveraged position in stock. The stochastic volatility model exacerbates this effect.

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