Indian equity options: smile, risk premiums, and efficiency

Abstract

We study the pricing of equity options in India which is one of the world's largest options markets. Our findings are supportive of market efficiency: A parsimonious smile‐adjusted Black model fits option prices well, and the implied volatility (IV) has incremental predictive power for future volatility. However, the risk premium embedded in IV for Single Stock Options appears to be higher than in other markets. The study suggests that even a very liquid market with substantial participation of global institutional investors can have structural features that lead to systematic departures from the behavior of a fully rational market while being “microefficient.”