Efficient Markets Hypothesis: A False Prophecy. Black-Scholes-Merton Formula: A Parlor Trick. Risk-Neutral Pricing Models: Severe Malpractices.
6 Pages Posted: 14 Feb 2015 Last revised: 12 Jun 2018
Date Written: February 12, 2015
In this notes, I argue and show that the so-called Efficient Markets Hypothesis (EMH) is no less than a false prophecy, the Black-Scholes-Merton (BSM) formula - a perfect rendition of EMH - no more than a parlor trick, and risk-neutral pricing models - generalisations of BSM - severe malpractices. In the rich history of financial economics, there have been more critiques of EMH and BSM than one can find in textbooks; however one find no arguments more convincing than one good numerical illustration which I shall offer in this notes. Education is a very important part of the process through which social and intellectual values are instilled in younger generations. Through this notes, I hope to convey key messages to the community of non-economists and non-mathematicians, be they the humble citizens including my parents who have worked hard paying tax and sending their kids, students of financial economics and financial engineering, to schools not to earn decent education, but only to be brain-washed with false prophecies and armed with dangerous tricks. This notes, in a certain way, is more than 'financial economics and finanical engineering for dummies'.
Keywords: efficient markets; martingale; risk; return; risk-neutral pricing; implied volatility
JEL Classification: A00, A01, A02, C00, C01, C02, C05, D04, F02, G00, G01, G02, G03, H00, H04, N00, N01, N02
Suggested Citation: Suggested Citation