ANOMALIES IN OPTION PRICING - THE BLACK-SCHOLES MODEL REVISITED

In 1973, Myron Scholes and the late Fischer Black published their semi nal paper on option pricing. The Black-Scholes model revolutionized fi nancial economics in several ways: It contributed to our understanding of a wide range of contracts with option-like features, and it allowe d us to revise our understanding of traditional financial instruments. This article addresses the question of how well the Black-Scholes mod el of option pricing works. The goal is to acquaint a general audience with the key characteristics of a model that is still widely used, an d to indicate the opportunities for improvement that might emerge from current research. The article reviews the key features of the Black-S choles model, identifying some of its most prominent assumptions. The author then employs recent data on almost one-half million options tra nsactions to evaluate the Black-Scholes model. He discusses some of th e reasons why the Black-Scholes model falls short, and goes on to asse ss recent research designed to improve our ability to explain option p rices.