Using visual exploratory data analysis to find bias in option pricing models

Options are amongst the most heavily transacted financial instruments in the world. This paper examines how the methods of visual exploratory tools, espoused by Cleveland (1993) can be used to analyze the residuals from conventional option pricing models (Black and Scholes, 1972; Black, 1976). Until recently, these models were believed to be unbiased (Rubinstein, 1985; Lajbcygier, 1999). With the aid of visual exploratory tools we see that options on the All Ordinaries share price index trading on the Sydney Futures exchange have persistent, systematic and significant bias. This is the first time that various statistically oriented visual exploratory tools have been used to analyze option residuals. We find that the analysis motivates the use of alternative option pricing methods.