Yes the paper out sensor is hardware based. It can be optical or physical inside the printer. You will have to take the printer apart to fudge the paper sensor.
Also, pin 12 of the parallel interface goes high (that is, shows +5V) to show an out of paper error. Therefore you should also be able to remove the pin 12 signal (cut / unsolder / pull pin, etc) and it should also work. However, with modern priners the way they are, there is no guarantee as that sensor line can be programmed for anything nowadays... Your mileage may vary...