Options and earnings announcements: An empirical study for the European Options Exchange

M.W.M. Donders, A. C F Vorst

Research output: Contribution to JournalArticleAcademicpeer-review

Abstract

In this paper we give an introduction in option pricing theory and explicitly specify the Black-Scholes model. Although market participants use this and similar models to price options, they violate one of the fundamental assumptions of the model. They do not set a constant value for the volatility of the underlying asset over time, but change the volatility even during a day. By means of event study methodology we investigate the volatility of the underlying asset and the volatility implicit in option prices around earnings announcements by firms. We find that the volatility in option prices increases before the announcement date and drops sharply afterwards. The volatility of the underlying stocks is higher only at the announcement dates and we do not observe a higher volatility around these dates. Hence, the constant volatility of the underlying asset, which is one of the assumptions in the Black-Scholes model, does not hold. However, the market seems to correctly anticipate the change in volatility, by correcting option prices.

Original languageEnglish
Pages (from-to)52-68
Number of pages17
JournalStatistica Neerlandica. Journal of the Netherlands Society for Statistics and Operations Research
Volume50
Issue number1
DOIs
Publication statusPublished - Mar 1996

Keywords

  • Earnings announcements
  • Event study methodology
  • Options

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