May 27th, 2011, 12:30 pm
QuoteOriginally posted by: pimpelQuoteOriginally posted by: rweinshQuoteOriginally posted by: ronmQuotewhat is the difference between a volatility of vanilla option (say,30 day ATM call) and a volatility of exotic (say,30 day ATM up&out call)If I think in this way propably, I may get some meaningful answer:In pricing many exotic options, you need to work with some **modified version of volatility i.e. Sigma** to be feed into the pricing formula. This may involve some arithmatics with raw sigma, underlying price, or other known inputs. This in not the case for vanilla option (atleast if I go with BS formula). This modified Sigma can be thought of volatility of exotic.Thanks,I`ve never heard about that .Where can I get an explanation what sigma is and a formula to calculate/estimate that,please?I think Rebonato's book is biggest in volume on the topic. But I would rather encourage you to make a graph I asked and think it over. If you still don't understand what I asked you read Paul Wilmott on Quantitative Finance. Maybe you will understand then, that the implied volatility exists only for options, which have strictly monotonic relationship between vol and price. The example I give you has a quadratic form (you would see a parabola). Vanillas are quoted by means of implied vol, but exotics by price, since there is no prevailing model, like B-S for vanillas. I like Rebonato's sentence about implied vol, something like "the wrong number, to put into wrong formula, to get the right price".I understood that...But I am trying to understand how market maker prices those exotics?(for vanilla he may use "wrong number" like implied volatility with "wrong formula")