Implied volatility vs. one from modeling

DopplerEffect · January 10th, 2008, 7:06 pm

I got the following question at an interview."Suppose your implied volatility is 20% and you also did some modeling and you got 21%. Which one will you use to price an option?"I didn't understand the question and don't know what kind of modeling was meant there, and there was no time to clarify... Maybe somebody can share some thoughts? thank you very much!

diogenes · January 10th, 2008, 9:53 pm

Well, you can argue with market and ignore implied, but implied would be my final answer since I did not have to do any work to get it. Now, I suppose if your modeling was good and you knew then maybe not.

DopplerEffect · January 10th, 2008, 10:39 pm

Well, my answer was implied, but he said implied volatility tells us about the past of the stock, not necessarilily the stock will have the same implied volatility in the future....I don't think there is supposed to be a final answer, maybe he tried to initiate some sort of a discussion? Maybe he wanted to hear something like: use the implied volatility for a short time interval, then recalculate it, etc.

diogenes · January 10th, 2008, 11:14 pm

Seems fair enough; after all why you would want to trust anything with a vague modeling given as the foundation. Yet, implied would give you the option vol based on current market expectations (assuming adequate liquidity), for vanilla options.I would not worry about it.