The 1987 crash permanently broke Black-Scholes fit with market prices

Evidence

In chapter 7, however, I draw on the econometric literature on option pricing to note that after the 1987 crash the fit between the Black-ScholesMerton model and patterns of market prices deteriorated markedly. A “volatility skew” or “smile” at odds with Black-Scholes emerged, and it seems to be durable; it has not subsequently diminished or vanished. Option theory has left its permanent imprint on the options markets: the theory is embedded in how participants talk and in technical devices that are essential to their markets. But what is performed in patterns of prices in those markets is no longer classic option-pricing theory. — Donald MacKenzie, An Engine, Not a Camera, 150

Categorization

• XREF: The ‘volatility smile’ and its durability connects to behavioral finance literature on option pricing anomalies and Merton’s later work. — connects to: The 1987 crash permanently shifted the S&P options market’s implied distribution toward crash expectations. — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 143; The 1987 crash ended the Black-Scholes model’s empirical fit for good — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 904; The 1987 crash exposed limits of arbitrage as a mechanism linking markets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 822 (+10 more)

Broader Connections

• The 1987 crash ended the Black-Scholes model’s empirical fit for good #corroborates (1.00) — Donald MacKenzie, An Engine, Not a Camera, 904
• The October 1987 crash ended the flat volatility curve predicted by Black-Scholes #corroborates (0.95) — Donald MacKenzie, An Engine, Not a Camera, 900
• Post-1987 index put prices consistently exceeded Black-Scholes levels #exemplifies (0.90) — Donald MacKenzie, An Engine, Not a Camera, 892
• The 1987 crash ended the Barnesian performativity of classic option-pricing theory #expands (0.85) — Donald MacKenzie, An Engine, Not a Camera, 942
• Explaining post-1987 option prices requires crash frequencies roughly four times historical rates #expands (0.82) — Donald MacKenzie, An Engine, Not a Camera, 913
• The 1987 crash exposed limits of arbitrage as a mechanism linking markets #expands (0.72) — Donald MacKenzie, An Engine, Not a Camera, 822
• Market infrastructure itself failed under the 1987 crash’s order flow #expands (0.72) — Donald MacKenzie, An Engine, Not a Camera, 820