Test of pricing efficiency of option model in Indian stock market

Abstract

In the present world, the financial uncertainty has become a part of life. As the business is continuously evolving, so is the financial market too so as to match the growing needs. As we see there is a continuous development and improvement to bring out different financial instruments to cover on the basis of different risk, So, derivatives have become an integral part of financial market. Traders, speculators and arbitragers started using derivative to solve this uncertainty as risk management tool, hence the efficiency and accuracy of the market became more important than ever. So, there is a great need to investigate into these aspects in order to test the pricing efficiency of option in the Indian stock market. newlineIn this research work, an attempt has been made to find out the relevance of Black-Scholes model in option pricing accuracy and also estimating the unbiased implied volatility and which will used to calculate BS option price. Also, to compare the model option price with the market option price in order to test whether predicted option values of the BS option model in present market condition holds acceptable or not. Additionally, I have also analyzed Greek s option and to know, how one can use the Greeks option for trading and also for better trading strategies. It was found from the study that, coefficients of implied volatilities are observed to be significant and it can be confirmed that implied call and put volatilities are informational predictors of future realized volatility, even though BS Model has predicted the price with 95% accuracy in only 6816 options which is approximately 34%. As many as 18193 option samples are found to be within 40% error out of total options of 20174 samples. The BS model has predicted significantly large number of options within an allowed or reasonable acceptable pricing and very few options have large errors. As a conclusion, the study found out that the option values have no significant relevance to the market values as the BS model constantly misprices the option prices, it fails to give an accurate and efficient option pricing. newline