Traders arbitraging model discrepancies directly improved the model’s econometric test results

Evidence

Given the above discussion of econometric testing, it is worth remarking that a trader using spreading would have been exploiting and thus reducing precisely the discrepancies in options prices that were the focus of the most sophisticated econometric testing of the Black-Scholes-Merton model in this period. (As has been noted, this testing was conducted by the financial economist Mark Rubinstein.) It therefore seems plausible that the use of the model in spreading did more than add generally to its verisimilitude; spreading may have had a direct effect on specific features of price patterns examined in the model’s econometric tests. — Donald MacKenzie, An Engine, Not a Camera, 146

Categorization

• DEEPTHINKING: A beautifully specific instance of the performativity thesis: the very use of the model in arbitrage closes the pricing discrepancies that econometric tests measure, so theory doesn’t just discover but produces its own verification — a feedback loop.
• XREF: Connects directly to the book’s main performativity argument as well as to literatures on reflexive social science (Giddens double hermeneutic) and on models as self-fulfilling. — connects to: Traders’ arbitrage activity made the pricing model appear empirically true — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 126; Using a model can make markets conform less well to it. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 92; Econometric model tests can be passed because traders’ arbitrage removes model deviations. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 737 (+4 more)

Broader Connections

• Econometric model tests can be passed because traders’ arbitrage removes model deviations. #corroborates (0.95) — Donald MacKenzie, An Engine, Not a Camera, 737
• Market actions based on efficient-market models can create anomalies those models cannot explain #complicates (0.72) — Donald MacKenzie, An Engine, Not a Camera, 1166
• Large samples average out random variation to reveal underlying economic laws #complicates (0.72)