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These observed mispricing patterns are generally thought to The magnitude of these biases has tended to increase since the Tie Su is an Assistant Professor of Finance at the University of Corrado is an Associate Professor of Finance at the Please directĬorrespondence to Charles J. University of Missouri System Research Board. Research for this article was supported by a grant from the Rubinstein (1994) also points out that strike price biasesĪssociated with the Black-Scholes model have been especially severeįor S&P 500 index options since the October 1987 market crash Tends to systematically misprice in-the-money and out-of-the- money Rubinstein (1985, 1994) all report that the Black-Scholes model Well-known studies by Black (1975),Įmanuel and MacBeth (1982), MacBeth and Merville ( 1 979), and Pricing biases associated with the Black-Scho- les option pricing Misprices deep in-the-money and deep out-of-the-money options. Price at-the-money options, the Black-Scholes model frequently For example, when calibrated to accurately Popularity, how- ever, the model has some known deficiencies inĪctual applications.

The Black-Scholes ( 1973) option pricing model is a universal S&P 500 INDEX OPTION TESTS OF TARROW AND RUDDS APPROXIMATE Corrado is an Associate Professor of Finance at the University of Missouri- Tie Su is an Assistant Professor of Finance at the University of Miami. Corrado, 2 14 Middlebush Hall, University of Missouri, Columbia, MO 652 1 1, (573) 882-5390. Please direct correspondence to Charles J. Rubinstein (1994) also points out that strike price biases associated with the Black-Scholes model have been especially severe for S&P 500 index options since the October 1987 market crash and that Research for this article was supported by a grant from the University of Missouri System Research Board. Well-known studies by Black (1975), Emanuel and MacBeth (1982), MacBeth and Merville (1 979), and Rubinstein (1985, 1994) all report that the Black-Scholes model tends to systematically misprice in-the-money and out-of-the- money options. Pricing biases associated with the Black-Scho- les option pricing model are well documented. For example, when calibrated to accurately price at-the-money options, the Black-Scholes model frequently misprices deep in-the-money and deep out-of-the-money options. Despite its widespread popularity, how- ever, the model has some known deficiencies in actual applications. CORRADO TIE SU INTRODUCTION The Black-Scholes ( 1973) option pricing model is a universal standard among option valuation models. S&P 500 INDEX OPTION TESTS OF TARROW AND RUDD’S APPROXIMATE OPTION VALUATION FORMULA CHARLES J.