FRM Part II · FRM Exam Part II · Volatility Smiles and Volatility Surfaces
For equity index options, which description of how the volatility smile typically changes as option maturity increases is most consistent with market observation?
The smile becomes less pronounced as maturity increases. Short-dated options show the most curvature or skew, while long-dated options show flatter patterns, so the volatility surface flattens along the maturity axis.
- AThe smile (skew) becomes less pronounced for longer maturitiesCorrect
- BThe smile becomes more pronounced for longer maturities
- CThe smile disappears at short maturities
- DThe smile is identical across all maturities
Explanation
Empirically, the volatility smile is more pronounced for short-dated options, and the effect of skew and smile decreases as maturity increases. This is why surfaces flatten along the maturity axis at long expiries.
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