Contextualizing Black-Scholes

Feb 19, 2019

Hello all blog readers,

Today I will discuss my readings “On Valuing American Call Options with the Black-Scholes European Formula” and “Tests of the Black-Scholes and Cox Call Option Valuation Models: Discussion” The reason I have chosen the first reading is because I believe I must learn about the initial assumptions of Black-Scholes. I have chosen the second reading to familiarize myself with other models and their comparisons with Black-Scholes. In order to understand this, you must know a little about the 5 inputs of Black-Scholes and what they mean. If you don’t, please read the according information online.

Takeaways from the first reading:

On Valuing American Call Options with the Black-Scholes European Formula”:

1)

Empirical finds prove¬†¬†“biases” have been found related to the exercise price, the time to maturity, and the variance.

2)

Black-Scholes systematically underpriced deep out-of-the-money options and near-maturity options while it overpriced deep in-the-money options during the 1973-1975 period.

 

3)

The original exercise price biases have been found to reverse themselves during certain time periods, so that both in- and out-of-the-money call options can be over- or underpriced by the Black-Scholes model depending on the sample of data being analyzed. More consistently, the model has been found to underprice near-maturity options.

 

Takeaways from the second reading:

“Tests of the Black-Scholes and Cox Call Option Valuation Models: Discussion“:

1)

The Cox equation is a special case of Black-Scholes making it at least as good at predicting option prices.

2)

Neither equations can properly predict American options.

My personal takeaways:

The technical math relating to options are much more difficult than I originally imagined. Please read said texts if you want to see what I mean. However, through these readings, I believe I have learned a lot about the biases and assumptions Black-Scholes incorporates and this will definitely help me as I am creating my Excel Spreadsheet.

 

Thanks for reading.

 

 

2 Replies to “Contextualizing Black-Scholes”

  1. Shreyas M. says:

    Very interesting personal takeaways! I am eager to see your project through the 12 weeks!

  2. Rohit P. says:

    Good looking stuff!

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