Explanation

Let's analyze each option:

A. There is higher implied price volatility for away-from-the-money equity options.

• Incorrect: In equity markets, we typically observe a volatility smile/skew where out-of-the-money put options (downside protection) have higher implied volatility than at-the-money options. This is due to investors' fear of market crashes and demand for downside protection.

B. "Crashophobia" suggests actual equity volatility increases when stock prices decline.

• Incorrect: Crashophobia refers to the psychological fear of market crashes that causes investors to bid up the prices of out-of-the-money put options, leading to higher implied volatility for these options. It doesn't necessarily mean actual volatility increases when prices decline.

C. Compared to the lognormal distribution, traders believe the probability of large down movements in price is similar to large up movements.

• Incorrect: In equity markets, traders actually believe the probability of large down movements is greater than large up movements, which is why we see the volatility skew (higher implied volatility for out-of-the-money puts than calls).

D. Increasing leverage at lower equity prices suggests increasing volatility.

• Correct: This is known as the leverage effect. When stock prices decline, companies' debt-to-equity ratios increase (higher financial leverage), making the equity more volatile. This relationship between declining prices and increasing volatility is a well-documented phenomenon in equity markets.

The correct answer is D because the leverage effect is a fundamental relationship in equity markets where declining stock prices lead to higher financial leverage, which in turn increases equity volatility.