IE Business School invites you to live the IE experience in real-time with a member of our world-class faculty. Enjoy a case discussion with Prof. Gamaliel Martinez, Professor of Operation Management with more than 20 years of experience in consulting in industries like Shipbuilding, Automative, Agrofood, Pharma. You can actively participate debating about the general…Details
Students from IE Business School, Universidad Complutense de Madrid and Hamline University have won the second edition of JPMorganâ??s Good Venture Competition. The competition focuses on developing philanthropic non-profit organisations. This year 77 socially responsible teams from 48 universities and business schools pitched for $25,000 of direct funding from JPMorgan. Ultimately nine teams were selected…Details
FUND MANAGEMENT: Real life gets in the way of BSM certainty
The following article was published in Financial Times on December 10, 2007 and written by Pablo Triana, Director of the Centre for Advanced Finance at IE. If you wish to learn more about our finance related programs, please visit http://www.miaf.ie.edu/.
The recent debate on the Black-Scholes-Merton options pricing model continues to make waves. Research by veteran option traders and authors Nassim Taleb and Espen Haug claims that BSM was not really an original invention, that its real-world popularity has been greatly exaggerated, and that there may be no mathematical models behind option prices, with simple supply-demand interaction claiming authorship instead.
Such bold statements, while a welcome contribution to the search for truth, may deprive us of something that seemed valuable. BSM, for all its flaws, offered quantifiable light where before there was only unknown darkness. By “losing” BSM, we would lose such certainty, albeit misplaced.
The most obvious certainty that the model offered was a precise number for the value of an option. This it did in a quite ingenious way. Everyone would tell you that an option should cost money because it gives you the right to enjoy a potentially large pay-out while limiting the possible losses if things do not go your way. But who ensures that that right has value per se? That value is supposed to come from the probability assigned to the option expiring in-the-money. So who guarantees that the probability of making money on the option is non-zero? Who can honestly claim to know the exact distribution governing financial assets? Pricing options based simply on probabilistic assumptions sounds a bit fishy.
Happy New Year 2008
On behalf of IE Business School, the Asia-Pacific Blog team wishes you a merry X-mas and a prosperous and an even more successful 2008.
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