An Empirical Study of the Option Pricing Formula with the Underlying Banned from Short Sell

Short sell bans are often imposed during a financial crisis as a desperate measure to stabilize financial markets. Yet, the impact of short sell bans on option pricing and hedging is not well quantitatively studied until very recently when Guo and Zhu (2017) and He and Zhu (2018) formulated a new pricing framework with the underlying being either completely or partially banned from short selling. However, no empirical results were provided to substantiate the usefulness of the formulae, as well as to deepen our understanding on the effects of short sell bans. This paper provides a comprehensive empirical study on the effects of short sell bans to the standard option pricing theory by carrying out both cross-sectional and options time series model calibration of the model devised by He and Zhu (2018). Overall, our empirical results indicate that the alternative option pricing formula considering short sell restrictions has the ability to capture highly-quoted implied volatility, with an evident improvement of 39% out-of-sample performance compared to the benchmark Black-Scholes model during the period of short sell ban.