Modelling option prices in Australia using the black-scholes model

Abstract

This paper provides evidence on the ability of the Black-Scholes model to price options traded on the Australian market. The only variable in the Black-Scholes model which is likely to be subject to significant measurement error is the standard deviation rate. Two different methods of estimation are examined here: historically-based and implied standard deviations. Using historical estimates of the standard deviation rates resulted in significant underpricing by the model relative to the market. This underpricing was consistent across in/out and short/long options with the latter proving particularly troublesome for the model. As would be expected, the use of weighted implied standard deviat..