Derman and Taleb's 'the Illusions of Dynamic Replication': A Comment

Abstract

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