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

Author

Listed:
  • 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.

Suggested Citation

  • Ramazan Gencay & Aslihan Salih, 2003. "Degree of Mispricing with the Black-Scholes Model and Nonparametric Cures," Annals of Economics and Finance, Society for AEF, vol. 4(1), pages 73-101, May.
  • Handle: RePEc:cuf:journl:y:2003:v:4:i:1:p:73-101
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Gradojevic Nikola, 2016. "Multi-criteria classification for pricing European options," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 20(2), pages 123-139, April.
    2. 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.

    More about this item

    Keywords

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

    JEL classification:

    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets

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