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On CAPM and Black-Scholes, differing risk-return strategies

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Author Info
McCauley, Joseph L.
Gunaratne, Gemunu H.

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Abstract

In their path-finding 1973 paper Black and Scholes presented two separate derivations of their famous option pricing partial differential equation (pde). The second derivation was from the standpoint that was Black’s original motivation, namely, the capital asset pricing model (CAPM). We show here, in contrast, that the option valuation is not uniquely determined; in particular, strategies based on the delta-hedge and CAPM provide different valuations of an option although both hedges are instantaneouly riskfree. Second, we show explicitly that CAPM is not, as economists claim, an equilibrium theory.

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File URL: http://mpra.ub.uni-muenchen.de/2162/
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Publisher Info
Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2162.

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Date of creation: 2003
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Handle: RePEc:pra:mprapa:2162

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Related research
Keywords: Capital asset pricing model (CAPM); nonequilibrium; financial markets; Black-Scholes; option pricing strategies;

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Find related papers by JEL classification:
C0 - Mathematical and Quantitative Methods - - General
D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
C65 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Miscellaneous Mathematical Tools

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  1. B. Rosenow & V. Plerou & P. Gopikrishnan & H. E. Stanley, 2001. "Portfolio Optimization and the Random Magnet Problem," Quantitative Finance Papers cond-mat/0111537, arXiv.org. [Downloadable!]
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