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Anomalies in option pricing: the Black-Scholes model revisited

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  • Peter Fortune

Abstract

In 1973, Myron Scholes and the late Fischer Black published their seminal paper on option pricing. The Black-Scholes model revolutionized financial economics in several ways: It contributed to our understanding of a wide range of contracts with option-like features, and it allowed us to revise our understanding of traditional financial instruments. This article addresses the question of how well the Black-Scholes model of option pricing works. The goal is to acquaint a general audience with the key characteristics of a model that is still widely used, and to indicate the opportunities for improvement that might emerge from current research. The article reviews the key features of the Black-Scholes model, identifying some of its most prominent assumptions. The author then employs recent data on almost one-half million options transactions to evaluate the Black-Scholes model. He discusses some of the reasons why the Black-Scholes model falls short, and goes on to assess recent research designed to improve our ability to explain option prices.

Suggested Citation

  • Peter Fortune, 1996. "Anomalies in option pricing: the Black-Scholes model revisited," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 17-40.
    • Handle: RePEc:fip:fedbne:y:1996:i:mar:p:17-40
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    Citations

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    Cited by:

    1. Shiller, Robert J., 1999. "Human behavior and the efficiency of the financial system," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 20, pages 1305-1340, Elsevier.
    2. Olkhov, Victor, 2019. "New Essentials of Economic Theory," MPRA Paper 95065, University Library of Munich, Germany.
    3. Molintas, Dominique Trual, 2021. "Black Scholes Model," MPRA Paper 110124, University Library of Munich, Germany.
    4. Gan, Lirong & Wang, Huamao & Yang, Zhaojun, 2020. "Machine learning solutions to challenges in finance: An application to the pricing of financial products," Technological Forecasting and Social Change, Elsevier, vol. 153(C).
    5. Brisset, Nicolas, 2017. "On Performativity: Option Theory And The Resistance Of Financial Phenomena," Journal of the History of Economic Thought, Cambridge University Press, vol. 39(4), pages 549-569, December.
    6. Olkhov, Victor, 2019. "New Essentials of Economic Theory III. Economic Applications," MPRA Paper 94053, University Library of Munich, Germany.
    7. Echaust, Krzysztof, 2021. "Asymmetric tail dependence between stock market returns and implied volatility," The Journal of Economic Asymmetries, Elsevier, vol. 23(C).
    8. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.

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    Keywords

    options;

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