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)A and C.
E)A,B,and C.

Question

Quizplus · Accepted Answer

Studies have found that the Black-Scholes model generates values fairly close to the market prices of options (choice A), but it tends to overvalue deep in the money calls and undervalue deep out of the money calls (choice B). This mispricing is partly due to the possible early exercise of American options on dividend-paying stocks, which is not accounted for by the model (choice C). Therefore, the correct choice is D, as both A and C are true.

Empirical Tests of the Black-Scholes Option Pricing Model