Discussion Paper Details

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Title: Commodity Option Pricing Efficiency before Black Scholes Merton

Author(s): David Chambers

Publication Date: September 2019

Keyword(s): Black-Scholes, commodities, London Metals Exchange, Market Efficiency, Options, Performativity and Warrants

Programme Area(s): Economic History

Abstract: It is often thought that the arrival of the Black Scholes Merton (BSM) model of option pricing in the early 1970s allowed traders to understand how to price and value options with greater precision. Yet, our study suggests that interwar commodity option traders may have been able to intuit 'fair' value and to adjust their prices to changes in the market environment well before the advent of this innovative model. A scarcity of historical price data has limited empirical tests of option price efficiency well before BSM to prior studies of stock options in the 1870s and the early twentieth century which reach contrasting findings. This study deals with option pricing in a different market ?? commodities ?? during the interwar period. We conclude that option prices were closer to their BSM theoretical values than suggested by prior studies. Institutional differences between interwar commodity options market and stock option markets in the 1870s and the early twentieth century may partly account for this result. Furthermore, we find that interwar option prices were no more mispriced and were as sensitive to changes in volatility ?? the key valuation parameter in the BSM model ?? as in modern times.

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Bibliographic Reference

Chambers, D. 2019. 'Commodity Option Pricing Efficiency before Black Scholes Merton'. London, Centre for Economic Policy Research.