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Criticism of the Black-Scholes Model: But Why Is It Still Used? (The Answer Is Simpler than the Formula)

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  • Yalincak, Orhun Hakan

Abstract

The Black Scholes Model (BSM) is one of the most important concepts in modern financial theory both in terms of approach and applicability. The BSM is considered the standard model for valuing options; a model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. However, while the formula has been subject to repeated criticism for its shortcomings, it is still in widespread use. This paper provides a brief overview of BSM, its foundational underpinnings, as well as discusses these shortcomings vis-à-vis alternative models.

Suggested Citation

  • Yalincak, Orhun Hakan, 2005. "Criticism of the Black-Scholes Model: But Why Is It Still Used? (The Answer Is Simpler than the Formula)," MPRA Paper 63208, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:63208
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    File URL: https://mpra.ub.uni-muenchen.de/63208/1/MPRA_paper_63208.pdf
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    References listed on IDEAS

    as
    1. Hallerbach, W.G.P.M., 2004. "An Improved Estimator For Black-Scholes-Merton Implied Volatility," ERIM Report Series Research in Management ERS-2004-054-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    2. Steven Heston & Saikat Nandi, 1997. "A closed-form GARCH option pricing model," FRB Atlanta Working Paper 97-9, Federal Reserve Bank of Atlanta.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Melek AKSU & Şakir SAKARYA, 2018. "Pricing of Covered Warrants: An Analysis on Borsa İstanbul," Sosyoekonomi Journal, Sosyoekonomi Society.

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    More about this item

    Keywords

    Black-Scholes model; finance; financial modeling; financial theory; volatility; option pricing;
    All these keywords.

    JEL classification:

    • C0 - Mathematical and Quantitative Methods - - General
    • C00 - Mathematical and Quantitative Methods - - General - - - General
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • D0 - Microeconomics - - General
    • D00 - Microeconomics - - General - - - General
    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E03 - Macroeconomics and Monetary Economics - - General - - - Behavioral Macroeconomics
    • G1 - Financial Economics - - General Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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