Module: Financial Modelling P58827
Critically Evaluate Arguments of The Black-Schole
Date: 4 May 2014
Nowadays, B-S model is the most important option pricing in financial market. Since Black and Scholes (1973) published the famous option pricing model, then the option pricing theory has become the focus of academic research. Assuming BS formula, some do not fully comply with the real market conditions, because the assumptions of B-S model are simplicity. Therefore, many scholars started to suggest the new model to modify the B-S model, such as the volatility model, stochastic volatility and jump diffusion model so on. Many scholars explore evidence that most empirical results of these modified models are better than the BS model in different markets. This essay purpose is that examine the arguments about whether the Black-Scholes model is valid and useful in real financial world. This report critical the arguments form the assumptions of the Black-Scholes model, do not discusses from the Black-Scholes equation. In the first part of the report discussed the B-S model. The three different modified models presented in second part of the report, and finally some conclusions. 2. Black-Scholes Model
In 1973, Fischer Black and Myron Scholes published Black & Scholes, the famous formula is derived optional pricing for European options, to provide a rigorous mathematical calculation tool in the European option. The B-S model allowed traders no longer just based on their subjective forecast the evaluation of the European option. The B-S is a clear formula to use and help the investor easy to choose the right trading decisions. Subsequently, Chicago Board aware of its importance, so they input the B-S model of computer applications and found that most of the original B-S formula is only applicable to the evaluation of European stock purchase rights do not pay dividends. With the other scholars constantly modified, BS model is extended to evaluation of new financial products. This is a foundation of the market valuation of derivative financial hedging strategies, called an important milestone on financial development. So Scholes won the Nobel economics prize awards in 1997. 2.1. Black-Scholes equation
The value of a call option for a non-dividend-paying underlying stock in t...