Hi there, ASET April 2016 Q3i (in the Additional points section) says that "Market-consistent assumptions for the Black-Scholes formula would use risk-free rates observed in the market and market-derived volatilities, eg implied volatilities from other option prices." Why would the volatility be based on the volatility of other option prices as opposed to the volatility of the assets underlying the unit fund? Or, is the solution saying that we're using the implied volatility baked into option prices as a means of calculating/assuming the volatility of the assets underlying the UF? Why do we do this, rather than directly calculating the volatility of the underlying? Is it because that calculation would be backwards looking whereas the volatility baked into option prices is forwards looking (and so represents market view -> and so is considered market consistent)? Thanks, Matt
Hi Matt Yes, it's because that calculation would be backwards looking whereas the volatility baked into option prices is forwards looking and represents the market view and so is considered market consistent. Best wishes Mark
