Posts Tagged ‘convexity’

Smile, it’s Volga!

April 9, 2012

Armed with the Hardy Decomposition for option prices, it now becomes much easier to understand why the smile exists.

To be clear, options trader might use the smile to manage supply & demand, but here we discuss the mathematical basis for smile – which is important if you want to understand how to generate smile in a monte-carlo model.

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Why does the yield curve slope upwards?

January 26, 2012

In this post I give a short, but I think rather usefully direct reason for why the yield curve should slope upwards. All it requires is for you to put yourself in the shoes of an investor that has to lock up their money in a bond for a fixed amount of time (and a very simple piece of algebra).

Yes, you can find plenty of papers which give complicated economic reasons for why this should be the case, but I tend to think that it is the simple insights that explain most of what you see happening in financial markets.

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