Pricing Accuracy of Put-Option Valuation Models: Directional Bias Due to Risk Free Interest Rates

Abstract

The classical Black-Scholes formula reveals systematic biases in valuation of option prices (Geske and Roll 1984 and reference therein). Heo et al. (2015) also found the existence of similar biases in fractional quadratic option pricing models. These observed pricing biases depend on moneyness, the time to maturity, and volatility of underlying assets. Recently, we have noticed that pricing bias is also seemingly influenced by interest rates. This study compares pricing accuracy across several put option models and investigates pricing biases caused by risk-free LIBOR using daily data of Yahoo put options traded in CBOE from February 2005 to February 2015.