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On the Consistency of the Black-Scholes Model with a General Equilibrium Framework

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  • Bick, Avi

Abstract

We construct a simple economy with consumption only at the final date in which we “endogenize” the stochastic behavior of prices assumed in the Black-Scholes model. Certain preferences (constant proportional risk aversion) and beliefs are shown to be sufficient and necessary, in certain respects, for the existence of such an equilibrium. The analysis is then generalized to a continuous-consumption framework, in which we embed the Merton proportional dividend model.

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  • Bick, Avi, 1987. "On the Consistency of the Black-Scholes Model with a General Equilibrium Framework," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 259-275, September.
  • Handle: RePEc:cup:jfinqa:v:22:y:1987:i:03:p:259-275_01
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    1. Galai, Dan & Masulis, Ronald W., 1976. "The option pricing model and the risk factor of stock," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 53-81.
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    3. James H. Scott Jr., 1976. "A Theory of Optimal Capital Structure," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 33-54, Spring.
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    5. Brennan, Michael J & Schwartz, Edwardo S, 1978. "Corporate Income Taxes, Valuation, and the Problem of Optimal Capital Structure," The Journal of Business, University of Chicago Press, vol. 51(1), pages 103-114, January.
    6. Kane, Alex & Marcus, Alan J & McDonald, Robert L, 1984. " How Big Is the Tax Advantage to Debt?," Journal of Finance, American Finance Association, vol. 39(3), pages 841-853, July.
    7. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    8. Constantinides, George M, 1978. "Market Risk Adjustment in Project Valuation," Journal of Finance, American Finance Association, vol. 33(2), pages 603-616, May.
    9. Kim, E Han, 1978. "A Mean-Variance Theory of Optimal Capital Structure and Corporate Debt Capacity," Journal of Finance, American Finance Association, vol. 33(1), pages 45-63, March.
    10. McDonald, Robert & Siegel, Daniel, 1984. " Option Pricing When the Underlying Asset Earns a Below-Equilibrium Rate of Return: A Note," Journal of Finance, American Finance Association, vol. 39(1), pages 261-265, March.
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