We report simple regressions and Granger causality tests in order to unders
tand the pattern of implied volatilities across exercise prices. We employ
all calls and puts transacted between 16:00 and 16:45 on the Spanish IBEX-3
5 index from January 1994 to April 1996. Transaction costs, proxied by the
bid-ask spread, seem to be a key determinant of the curvature of the volati
lity smile. Moreover, time to expiration, the uncertainty associated with t
he market and the relative market momentum are also important variables in
explaining the smile. (C) 1999 Elsevier Science B.V. All rights reserved.