Empirical tests of the Black-Scholes option pricing model
A)show that the model generates values fairly close to the prices at which options trade.
B)show that the model tends to overvalue deep in-the-money calls and undervalue deep out-of-the-money calls.
C)indicate that the mispricing that does occur is due to the possible early exercise of American options on dividend-paying stocks.
D)show that the model generates values fairly close to the prices at which options trade and indicate that the mispricing that does occur is due to the possible early exercise of American options on dividend-paying stocks.

Question

Quizplus · Accepted Answer

Empirical tests have shown that the Black-Scholes option pricing model generates values fairly close to the prices at which options trade. However, it tends to overvalue deep in-the-money calls and undervalue deep out-of-the-money calls. The mispricing that does occur is due to the possible early exercise of American options on dividend-paying stocks. Therefore, choice D is the best answer as it incorporates both of these aspects.

Empirical Tests of the Black-Scholes Option Pricing Model