TY - JOUR
T1 - Options and earnings announcements
T2 - An empirical study for the European Options Exchange
AU - Donders, M.W.M.
AU - Vorst, A. C F
PY - 1996/3
Y1 - 1996/3
N2 - 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.
AB - 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.
KW - Earnings announcements
KW - Event study methodology
KW - Options
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U2 - 10.1111/j.1467-9574.1996.tb01480.x
DO - 10.1111/j.1467-9574.1996.tb01480.x
M3 - Article
AN - SCOPUS:0030550862
SN - 0039-0402
VL - 50
SP - 52
EP - 68
JO - Statistica Neerlandica. Journal of the Netherlands Society for Statistics and Operations Research
JF - Statistica Neerlandica. Journal of the Netherlands Society for Statistics and Operations Research
IS - 1
ER -