Black-Scholes-Merton pricing fit observed options data only approximately at launch.

Evidence

The Black-Scholes-Merton model was not transcended, but supplemented. It was brilliant, productive theoretical work. But was it empirically valid? After constructing their formula for the pricing of call options (equation 2 in appendix D), Black and Scholes tested its empirical validity for the ad hoc New York options market, using a broker’s diaries in which were “recorded all option contracts written for his customers.” They found only an approximate fit: “in general writers [the sellers of options] obtain favorable prices, and … there tends to be a systematic mispricing of options as a function of the variance of returns of the stock” (Black and Scholes 1972, pp. — Donald MacKenzie, An Engine, Not a Camera, 625

Categorization

• QUESTION: The early empirical test found writers systematically got favorable prices — worth chasing how option writers’ profits persisted after the model was adopted by exchanges.
• XREF: connects to: Black-Scholes legitimized options despite fitting prices only approximately — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 707; Option market prices initially diverged from the Black-Scholes model but converged — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 735; Early CBOE options traded at prices wildly above Black-Scholes values — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 102

Broader Connections

• Black-Scholes legitimized options despite fitting prices only approximately #corroborates (0.92) — Donald MacKenzie, An Engine, Not a Camera, 707
• Option market prices initially diverged from the Black-Scholes model but converged #expands (0.88) — Donald MacKenzie, An Engine, Not a Camera, 735
• Early CBOE options traded at prices wildly above Black-Scholes values #qualifies (0.75) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 102