Identification and analysis of factors affecting the valuation error of option contract in the Black-Scholz-Merton model

Document Type : Original Article

Authors

1 Azad University Research Science Unit

2 Iran University of Science and Technology

3 Baqiyatallah University of Medical Sciences

4 Associate Professor, School of Industrial Engineering, Iran University of Science and Technology, Tehran, Iran.

Abstract

Due to the increase in the trading of option contracts in the last few years, the discussion of accurate and correct valuation of this financial instrument is raised and important. Despite the wide use of this model for the pricing of option contracts, this model has a calculation error. The present study aims to investigate the impact of three variables—historical volatility, the in-the-money status of the underlying asset in the options contract, and the time remaining until maturity—on the error of the Black-Scholes-Merton model in pricing options contracts. The analysis reveals discrepancies between the theoretical prices generated by the model and the actual market prices. Using Stata software and panel data regression, the influence of these three variables on the Black-Scholes-Merton model's error was estimated, and the results indicate a positive correlation between each of these variables and the model's error. This study utilized data from options contracts between 2019 and 2023. Furthermore, the Root Mean Square Error (RMSE) metric was calculated, revealing a 55% discrepancy between the prices estimated by the Black-Scholes-Merton model and the actual market prices.

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Main Subjects

References

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Budget and Finance Strategic Research
Volume 5, Issue 4 - Serial Number 20
Winter Quarterly
December 2024
Pages 71-93

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History

  • Receive Date: 30 August 2024
  • Revise Date: 23 October 2024
  • Accept Date: 08 December 2024

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