Empirical Tests of the Black-Scholes Option Pricing Model

question 13

Multiple Choice

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.

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Definitions:

Marginal Rate

Often referred to as the marginal rate of substitution or the marginal tax rate, indicating the rate at which one can trade off one good for another or the tax rate on the next dollar earned, respectively.

Substitution

Substitution refers to the economic principle where consumers replace more expensive items with less expensive ones or firms replace inputs with cheaper alternatives, in response to changes in price or availability.

Videocassette

A medium for the recording of analog audio and video tapes, now largely obsolete.

Diminishing Marginal Utility

The principle that the satisfaction or utility gained from consuming each additional unit of a good or service decreases as more of it is consumed over a certain period.