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

Empirical tests have shown that the Black-Scholes model generates values fairly close to the prices at which options trade (option A) but tends to overvalue deep in the money calls and undervalue deep out of the money calls (option B). Additionally, the mispricing that does occur is often attributed to possible early exercise of American options on dividend-paying stocks (option C). Therefore, choices A, B, and C are all partially true, but only choices A and C are fully supported by empirical testing. Thus, the best choice is D, which includes both A and C.

Empirical Tests of the Black-Scholes Option Pricing Model