Derman and Taleb's 'the Illusions of Dynamic Replication': A Comment
5 Pages Posted: 23 Mar 2006
Date Written: March 24, 2006
While as a matter of pure chance and mathematical manipulations, the Black-Scholes formula could have been accidentally obtained much earlier by making use of put-call parity, a simple thought experiment demonstrates the inconclusiveness of any such derivation as regards the validity of the resulting pricing equation. In particular, the use of a non-stochastic discount rate common to both the call and the put options is inconsistent with modern equilibrium capital asset pricing theory. Additional observations are made.
Keywords: Black-Scholes Formula, Option Pricing, Dynamic Replication
JEL Classification: B41, G13
Suggested Citation: Suggested Citation