Criticism of the Black-Scholes Model: But Why is It Still Used?: (The Answer is Simpler than the Formula)

11 Pages Posted: 22 Jul 2012 Last revised: 23 Mar 2015

Orhun Hakan Yalincak

State University of New York, Empire State College Alumnus; New York University, College of Arts and Sciences (Candidate)

Date Written: July 22, 2012

Abstract

The Black Scholes Model (BSM) is one of the most important concepts in modern financial theory both in terms of approach and applicability. The BSM is considered the standard model for valuing options; a model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. However, while the formula has been subject to repeated criticism for its shortcomings, it is still in widespread use. This paper provides a brief overview of BSM, its foundational underpinnings, as well as discusses these shortcomings vis-à-vis alternative models. This paper was originally written as a part of the course 'Derivatives & Capital Markets' in 2004, during my time at New York University under exam conditions. This present paper is an updated version with references.

Keywords: Black-Scholes-Merton, BSM, stochastic volatility, jump diffusion, Nassim Taleb, levy process, binomial tree, normal distribution, Gaussian, Brownian Motion

JEL Classification: C10, C60, F30, G30

Suggested Citation

Yalincak, Orhun Hakan, Criticism of the Black-Scholes Model: But Why is It Still Used?: (The Answer is Simpler than the Formula) (July 22, 2012). Available at SSRN: https://ssrn.com/abstract=2115141 or http://dx.doi.org/10.2139/ssrn.2115141

Orhun Hakan Yalincak (Contact Author)

State University of New York, Empire State College Alumnus ( email )

Vestal Parkway East
Binghamton, NY 13902
United States

New York University, College of Arts and Sciences (Candidate) ( email )

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