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FRM Part II · FRM Exam Part II · Volatility Smiles and Volatility Surfaces

Which statement about the equity volatility skew compared with the currency option volatility smile is most accurate?

Currency options typically show a fairly symmetric smile, with higher implied volatility for both low and high strikes, reflecting two-sided fat tails. Equity options instead show a downward-sloping skew, with implied volatility highest at low strikes and decreasing as strike rises.

  1. ACurrency smiles are roughly symmetric with higher implied volatility for both low and high strikes, while equity skews slope downwardCorrect
  2. BBoth are strongly downward sloping with higher volatility at high strikes
  3. CEquity skews are symmetric while currency smiles slope downward
  4. DNeither shows variation of implied volatility with strike

Explanation

Currency options tend to show a U-shaped smile because exchange rate returns have fat tails in both directions. Equity options show a downward skew with a heavy left tail. The other options misstate these shapes.

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