The Black-Scholes equation

http://terrytao.wordpress.com/2008/07/01/the-black-scholes-equation/

by getp • 18 years ago

9 9 18 years ago

terrytao.wordpress.com

giardini2• 18 years ago

Readers might be interested in Nicholas Nassim Taleb's paper "Why We Have Never Used the Black-Scholes-Merton Option Pricing Formula" available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1012075

from the abstract:

"we have historical evidence that

1) Black, Scholes and Merton did not invent any formula, just found an argument to make a well known (and used) formula compatible with the economics establishment, by removing the "risk" parameter through "dynamic hedging",

2) Option traders use (and evidently have used since 1902) heuristics and tricks more compatible with the previous versions of the formula of Louis Bachelier and Edward O. Thorp (that allow a broad choice of probability distributions) and removed the risk parameter by using put-call parity.

3) Option traders did not use formulas after 1973 but continued their bottom-up heuristics.

The Bachelier-Thorp approach is more robust (among other things) to the high impact rare event. The paper draws on historical trading methods and 19th and early 20th century references ignored by the finance literature. It is time to stop calling the formula by the wrong name."

An excellent summation of Taleb's critique is "Whither Black-Scholes?""

http://www.forbes.com/2008/04/07/black-scholes-options-oped-...

j2d22• 18 years ago

Readers would also enjoy the story of LTCM.

http://en.wikipedia.org/wiki/Long-Term_Capital_Management

chollida1• 18 years ago

Though they worked in bond arbitrage and didn't use Black Scholes:)

logjam• 18 years ago

Here's an alternative equation: bet on yourself, instead of on whether millions of others will succeed or fail.

giardini2• 18 years ago

I would rather hedge my bets.

Although one might temper one's judgement by reading "Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated Self-Assessments" by Justin Kruger and David Dunning of Cornell University"

http://www.apa.org/journals/features/psp7761121.pdf

Non-pdf URLs at:

http://www.google.com/search?hl=en&q=Unskilled+and+Unawa...

Should the article apply, one may be doomed!-)

steveplace2• 18 years ago

And you could bet on yourself by trading options ;)

ScottWhigham• 18 years ago

Am I the only one who clicked this hoping for an article about Paul Scholes? Oh well :)

The Black-Scholes equation

Related Stories