Volatility smile

A view that the probabilities of very large market movements - positive or negative - are greater than predicted by a simple random walk model of market prices. In other words, the view that market shows trending behaviour in relation to large market movements: 'Both panic and over-exuberance are contagious'.

This view is reflected in deeply out-of-the money options having greater implied volatilities (calculated from their greater traded values) than at-the-money options.

This view is also a potential explanation for leptokurtic frequency distributions. (Which have longer 'tails' of extreme values than the simpler Normal frequency distributions often used for modelling and calculation purposes.)

See also

• At the money
• Implied volatility
• Leptokurtic frequency distribution
• Out of the money
• Random walk
• Volatility