Warren Buffett, Black-Scholes and Long Dated Options

Abstract:     
In his 2008 letter to Berkshire shareholders, Warren Buffett presented a critique of the Black-Scholes option pricing model as a tool for valuing long-dated options, including options that Berkshire had written. Given Mr. Buffett’s track record, it worth investigating precisely why he thinks that the Black-Scholes model fails to provide a fair value for long-dated options. Unfortunately, the alleged deficiencies in the model are not transparent because Mr. Buffett’s letter fails to develop his viewpoint in terms of option pricing theory. This short article fills the gap by interpreting Mr. Buffett’s argument in the context of option pricing theory. It turns out that Mr. Buffett is really making a statement about political economics more than option pricing.

Keywords: Warren Buffett, Black-Scholes, option pricing

JEL Classifications: G10

Working Paper Series