Explaining post-1987 option prices requires crash frequencies roughly four times historical rates

Evidence

To explain observed index-option prices since 1988 thus requires the artificial addition to the actual price record of crashes of almost 1987’s severity more frequent than one every four years, when “even a 20% [one month] crash every eight years seems to be a rather pessimistic outlook” (Jackwerth 2000, p. 447). (Between 1802 and 1988 there were only seven calendar months in which the U.S. stock market fell by more than 20 percent [Schwert 1990, p. 80, table 1].) “The most likely explanation,” Jackwerth concludes (2000, p. 450), “is mispricing of options in the market.” — Donald MacKenzie, An Engine, Not a Camera, 913

Categorization

• XREF: The 1987 crash frequency required by option prices connects to risk-premium and rare-event literature (Barro, Rietz disaster models), and to the recurring theme in this book of the 1987 crash resetting market models. — connects to: Post-1987 option pricing may be rational given the crash’s trauma, not irrational. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 155; The 1987 crash permanently broke Black-Scholes fit with market prices — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 150; The persistent option skew reflects rational trauma from 1987, not mispricing — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 915 (+4 more)

Broader Connections

• The 1987 crash ended the Barnesian performativity of classic option-pricing theory #responds-to (0.85) — Donald MacKenzie, An Engine, Not a Camera, 942
• Option pricing theory did not describe markets but remade them in its own image #corroborates (0.80) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 182