Testing the Performance of Black and Scholes Pricing Model in the Indian Options Market

Abstract

Since its introduction in 2001, option markets have been growing at a phenomenal rate in India. One of the most basic and popular model used by traders to price an option contract is the Black and Scholes (BS) option pricing model. The model has been tested for its empirical performance by numerous authors throughout the world except India. The results in these studies have shown contradictory biases in the model. The present study is a step towards reducing this gap in the literature, and aims to test the BS model’s performance by employing time series data on NIFTY Index option contracts. In implementing the BS model, volatility of the underlying NIFTY Index is measured through the Random Walk model and the Historical Mean model. Many of the results found are contradictory to the systematic biases found in previous literature. These results are crucial for the traders while valuing the option contracts and creating portfolio diversification in the Indian markets.