AdvancedMultiple choice
When the model meets the market · Part 3 of 3
A desk prices one-year options on an equity index with Black–Scholes at a single volatility of 20%. The market prices the at-the-money option at 20% implied volatility but the 80-strike put at 28%.
The desk moves to a model that fits the skew and prices by Monte Carlo. With 10,000 paths the standard error of a price is 0.08. How many paths are needed to bring it to 0.02?
- A40,000, four times as many paths for a quarter of the error
- B160,000
- C20,000, since halving the error twice needs twice the paths
- D640,000
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