We analyze the properties of the implied volatility, the commonly used volatility estimator by direct option price inversion. It is found that the implied volatility is subject to a systematic bias in the presence of pricing errors, which makes it inconsistent to the underlying volatility. We...

This paper develops two tests for parametric volatility function of a diffusion model based on Khmaladze (1981)’s martingale transformation. The tests impose no restrictions on the functional form of the drift function and are shown to be asymptotically distribution-free. The tests are...