Do Swedes smile? On implied volatility functions

Abstract

The implied volatilities for Swedish equity options show a U-shaped smile pattern when averaged within groups according to the moneyness of the options. This makes the use of at-the-money implied volatilities for valuation of out-of- or in-the-money options questionable. Using at-the-money implied volatilities as benchmark it is, therefore, investigated whether some kind of implied volatility function could lead to more accurate model values. Although the benchmark model performs best for at-the-money options, the use of a volatility function could clearly improve the valuation accuracy for deep in-the-money options. However, no model works very well for options of all moneyness levels.