Degree of mispricing with the black-scholes model and nonparametric cures

Gençay R., Salih A.

Annals of Economics and Finance, vol.4, no.1, pp.73-101, 2003 (Scopus) identifier

  • Publication Type: Article / Article
  • Volume: 4 Issue: 1
  • Publication Date: 2003
  • Journal Name: Annals of Economics and Finance
  • Journal Indexes: Scopus
  • Page Numbers: pp.73-101
  • Keywords: Bagging, Bayesian regularization, Early stopping, Feedforward networks, Nonparametric methods, Option pricing
  • TED University Affiliated: No

Abstract

© 2003 by Peking University Press All rights of reproduction in any form reserved.The Black-Scholes pricing errors are larger in the deeper out-of-the-money options relative to the near out-of-the-money options, and mispricing worsens with increased volatility. Our results indicate that the Black-Scholes model is not the proper pricing tool in high volatility situations especially for very deep out-of-the-money options. Feedforward networks provide more accurate pricing estimates for the deeper out-of-the money options and handles pricing during high volatility with considerably lower errors for out-of-the-money call and put options. This could be invaluable information for practitioners as option pricing is a major challenge during high volatility periods.