The estimate of the future volatility of the returns on the underlying asset that is computed using the Black-Scholes option pricing model is referred to as the:
A) residual error.
B) implied mean return.
C) derived case volatility.
D) forecast rho.
E) implied standard deviation.

Question

Quizplus · Accepted Answer

The estimate of future volatility of returns on the underlying asset that is computed using the Black-Scholes option pricing model is referred to as the implied standard deviation. This is because the Black-Scholes model uses the current market price of an option, along with other inputs such as the strike price and time to expiration, to back out the implied volatility that must be consistent with that price. Therefore, the implied standard deviation is an estimate of the volatility that is implied by the market prices of options, rather than a direct estimate of historical or expected future volatility.

The Estimate of the Future Volatility of the Returns on the Underlying