THE RELATION BETWEEN OPTION MISPRICING AND VOLUME IN THE BLACK‐SCHOLES OPTION MODEL

Abstract

Abstract We investigate the relation between mispricing in the Black‐Scholes option pricing (BSOP) model and volume in the option market. Our results indicate heavily traded call options are priced more efficiently and have lower mispricing errors than thinly traded options. However, this relation shifts significantly on days when call option trading is high. On high‐volume days, the BSOP model mispricing errors are significantly larger than mispricing errors on normal‐volume days. We believe large increases in volume may reflect new and changing market information, thus making pricing less efficient in the BSOP model.