
The Black-Scholes equation - getp
http://terrytao.wordpress.com/2008/07/01/the-black-scholes-equation/
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giardini
Readers might be interested in Nicholas Nassim Taleb's paper "Why We Have
Never Used the Black-Scholes-Merton Option Pricing Formula" available at

<http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1012075>

from the abstract:

"we have historical evidence that

1) Black, Scholes and Merton did not invent any formula, just found an
argument to make a well known (and used) formula compatible with the economics
establishment, by removing the "risk" parameter through "dynamic hedging",

2) Option traders use (and evidently have used since 1902) heuristics and
tricks more compatible with the previous versions of the formula of Louis
Bachelier and Edward O. Thorp (that allow a broad choice of probability
distributions) and removed the risk parameter by using put-call parity.

3) Option traders did not use formulas after 1973 but continued their bottom-
up heuristics.

The Bachelier-Thorp approach is more robust (among other things) to the high
impact rare event. The paper draws on historical trading methods and 19th and
early 20th century references ignored by the finance literature. It is time to
stop calling the formula by the wrong name."

An excellent summation of Taleb's critique is "Whither Black-Scholes?""

[http://www.forbes.com/2008/04/07/black-scholes-options-
oped-...](http://www.forbes.com/2008/04/07/black-scholes-options-oped-
cx_ptp_0408black.html)

~~~
j2d2
Readers would also enjoy the story of LTCM.

<http://en.wikipedia.org/wiki/Long-Term_Capital_Management>

~~~
chollida1
Though they worked in bond arbitrage and didn't use Black Scholes:)

~~~
steveplace
They used options on bonds.

High leverage + quant statistical method + six sigma event = fun.

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ScottWhigham
Am I the only one who clicked this hoping for an article about Paul Scholes?
Oh well :)

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logjam
Here's an alternative equation: bet on yourself, instead of on whether
millions of others will succeed or fail.

~~~
giardini
I would rather hedge my bets.

Although one might temper one's judgement by reading "Unskilled and Unaware of
It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated
Self-Assessments" by Justin Kruger and David Dunning of Cornell University"

<http://www.apa.org/journals/features/psp7761121.pdf>

Non-pdf URLs at:

[http://www.google.com/search?hl=en&q=Unskilled+and+Unawa...](http://www.google.com/search?hl=en&q=Unskilled+and+Unaware+of+It%3A+How+Difficulties+in+Recognizing+One%27s+Own+Incompetence+Lead+to+Inflated+Self-
Assessments&btnG=Google+Search)

Should the article apply, one may be doomed!-)

