Choosing the Lognormal Mean for Black Scholes

[DiceAreCast]

Have you not yet noticed that this discussion quickly spiraled out of his competence limit? I already told you that he sometimes even cites content that actually weakens his claims. His original premise was that bs is outdated and not used anymore. Then he claimed that lstm used primarily bs and that's why they fucked up. Now he makes full circle and cites an article that rightly supports the fact that bs is still widely used today. Lol

while the wiki shares some of the shortcomings of the models it clearly explains why it’s still used by banks and other firms. Why would you post something that proves black scholes is a decent framework?

 

[SunTrader]

while the wiki shares some of the shortcomings of the models it clearly explains why it’s still used by banks and other firms. Why would you post something that proves black scholes is a decent framework?

The fact that it is used by too big to fail banks and other unnamed firms "proves" they haven't a clue. Why would you bother bringing that up ..... while avoiding the main point that it isn't a decent framework?

 

[newwurldmn]

The fact that it is used by too big to fail banks and other unnamed firms "proves" they haven't a clue. Why would you bother bringing that up ..... while avoiding the main point that it isn't a decent framework?

they failed because they overlevered giving credit to people who didn’t deserve it.

you keep attributing financial failures to an options model instead of to other more obvious factors.

 

[Kevin Schmit]

One thing I don't understand about Black Scholes is why the mean (drift) of the stock return lognormal distribution is set to the risk-free interest rate minus...

A number of posters have pointed out that pricing options off anything other than the risk-free rate would allow arbitrage, but I don't think anyone has actually explained that arbitrage to you. If you understood the arb, you would never have asked the question, so here is the explanation:

Price an ATM put and call (same expiry and underlying). Then simulate selling the call and simultaneously buying 100 shares of the stock, financed at the current risk-free rate, and buying the put. Then check what happens at expiry. You will find that in all situations, you have made money from the excess differential between the (overprices) call and the (comparatively underpriced) put.

Before you delve into the intricacies of BSM, and way before you dive into Shreve (not an undergraduate text!), you should learn about put-call parity and other basics.

 

[DiceAreCast]

Just curious what you think of Shreve's books? A bit dated but he has imo a talent to explain concepts very elegantly.

A number of posters have pointed out that pricing options off anything other than the risk-free rate would allow arbitrage, but I don't think anyone has actually explained that arbitrage to you. If you understood the arb, you would never have asked the question, so here is the explanation:

Price an ATM put and call (same expiry and underlying). Then simulate selling the call and simultaneously buying 100 shares of the stock, financed at the current risk-free rate, and buying the put. Then check what happens at expiry. You will find that in all situations, you have made money from the excess differential between the (overprices) call and the (comparatively underpriced) put.

Before you delve into the intricacies of BSM, and way before you dive into Shreve (not an undergraduate text!), you should learn about put-call parity and other basics.

 

[Kevin Schmit]

Just curious what you think of Shreve's books? A bit dated but he has imo a talent to explain concepts very elegantly.

He's your former professor at CMU, right?

It's a good book. IIRC it was published in 2005 or 2006. I'd say it's held up pretty well. Just not suitable for someone still struggling with the concept of put-call parity.

 

[LM3886]

A number of posters have pointed out that pricing options off anything other than the risk-free rate would allow arbitrage, but I don't think anyone has actually explained that arbitrage to you. If you understood the arb, you would never have asked the question, so here is the explanation:

Price an ATM put and call (same expiry and underlying). Then simulate selling the call and simultaneously buying 100 shares of the stock, financed at the current risk-free rate, and buying the put. Then check what happens at expiry. You will find that in all situations, you have made money from the excess differential between the (overprices) call and the (comparatively underpriced) put.

Before you delve into the intricacies of BSM, and way before you dive into Shreve (not an undergraduate text!), you should learn about put-call parity and other basics.

Well said, Kevin. Put-call parity makes no assumption about return distribution, mean, volatility, and all that stuff. There is nothing to be confused about.

 

[DiceAreCast]

Agree on suitability for OP. I addressed it to @newwurldmn

Let's just say I know Dr. Shreve personally and hold him in very high regard. He was instrumental in shaping my early career.

He's your former professor at CMU, right?

It's a good book. IIRC it was published in 2005 or 2006. I'd say it's held up pretty well. Just not suitable for someone still struggling with the concept of put-call parity.

 

[jys78]

Well, bs is still used every day by quants and everyone on wall street. But it should not be misunderstood. It's a translation device between prices and implied volatility. Not as a means to value an option.

Imagine if this were true.

 

[DiceAreCast]

Bait?

Imagine if this were true.