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Degree of Mispricing with the Black-Scholes Model and Nonparametric Cures

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Author Info

  • Ramazan Gencay

    (Department of Economics, University of Windsor)

  • Aslihan Salih

    (Faculty of Business Administration, Bilkent University)

Abstract

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.

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Bibliographic Info

Article provided by Society for AEF in its journal Annals of Economics and Finance.

Volume (Year): 4 (2003)
Issue (Month): 1 (May)
Pages: 73-101

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Handle: RePEc:cuf:journl:y:2003:v:4:i:1:p:73-101

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Related research

Keywords: Option pricing; Nonparametric methods; Feedforward networks; Bayesian regularization; Early stopping; Bagging;

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References

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Cited by:
  1. Nikola Gradojevic & Dragan Kukolj & Ramazan Gencay, 2011. "Clustering and Classification in Option Pricing," Review of Economic Analysis, Rimini Centre for Economic Analysis, vol. 3(2), pages 109-128, October.

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