The post-1987 volatility skew became a permanent feature of index options
Evidence
The earlier flat line has not returned subsequently (see, for example, Jackwerth 2000); indeed, the skew continued to grow at least until 1992 (Rubinstein 1994, pp. 772-774). The direction of the skew has been stable: puts with strike prices well below current stock index levels have higher implied volatilities are relatively more expensive than puts with higher strike prices, and the putcall parity relation discussed in chapter 6 means that the same is true of calls. — Donald MacKenzie, An Engine, Not a Camera, 901
Categorization
- XREF: The persistent, growing skew is precisely the empirical anomaly that the subsequent ‘smile’ and stochastic-volatility models (Heston, etc.) were built to explain—connects to modern derivatives literature. — connects to: The 1987 crash permanently shifted the S&P options market’s implied distribution toward crash expectations. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 143; Post-1987 index put prices consistently exceeded Black-Scholes levels — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 892; The October 1987 crash ended the flat volatility curve predicted by Black-Scholes — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 900 (+9 more)
Broader Connections
- The persistent option skew reflects rational trauma from 1987, not mispricing
#exemplifies(0.85) — Donald MacKenzie, An Engine, Not a Camera, 915 - Index option prices embed a skew that actual price movements do not justify
#expands(0.80) — Donald MacKenzie, An Engine, Not a Camera, 911 - Black-Scholes fit option prices well for eleven years, then stopped after 1987
#expands(0.80) — Donald MacKenzie, An Engine, Not a Camera, 902 - The skew’s persistence after 1987 undermines the discovery narrative of option pricing
#qualifies(0.75) — Donald MacKenzie, An Engine, Not a Camera, 1163 - Post-1987 German options skew ran opposite to the U.S. skew
#contradicts(0.75) — Donald MacKenzie, An Engine, Not a Camera, 1590 - The post-1987 options skew was primarily an American rather than global phenomenon
#qualifies(0.72) — Donald MacKenzie, An Engine, Not a Camera, 921