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Is BlackSchole formula beautiful or a BullShit formula?

coolarbitrager

Joined
7/24/14
Messages
8
Points
13
Hi debaters,

In my years of trading, i've heard enough ppl talking about this so-called BS (BullShit) formula but i've never used. Let me tell you academics and quants: the assumption of constant volatility is of course absurd. Implied volatility is your distraction which hides your stupid view of the future and risk. All current mathematical models and approaches are not new and useless, and are repeatedly taught thru the last 40 years. How are they useful at all in explaining the crash and crisis we have had over the years? The so-called arbitrage-free theory proposed by Merton is absurd! Why? If the market were arbitrage-free, how did he and Schole make ~40% over the years before their LTCM collapsed? Now they hide themselves in universities just to show that the market is now arbitrage-free, no money out there to make?! Should i say "BSM formula = BullShitMate formula"?

Anyone cares to debate? Before you do, do read the works by Nassim Taleb (Black Swans) and Pablo Triana (The flawed math of financial models).

Cool arbitrager
 
Arrogant?! Haha...Merton and Scholes were so arrogant in believing in their own creation, the BSM formula and arbitrage free theory, and brought down the world economy in 1997 with their LTCM collapse. Who are the arrogant here? You're a narrow-minded oxymoron!
 
I don't think you know what an oxymoron is, at least it doesn't seem like you're using the word in the correct context.

Also, how is your account not banned yet?
 
There are a lot of pricing models now that do allow for stochastic volatility. One of them is the Heston model. It has been around for a while.

Also, from my understanding, arbitrage free pricing theory does not mean that there is no arbitrage in the markets. The other way around, it is a good way to find arbitrage opportunities. Value an option (arbitrage free price) -> compare it to market price -> take into account other factors (incomplete markets, transaction costs) -> decide if arbitrage opportunity exists.

Also, if you are interested in new theory, I'd recommend you to read the Adaptive Market Hypothesis by Andrew Lo. It is a great read.
 
diegosanaz said:
There are a lot of pricing models now that do allow for stochastic volatility. One of them is the Heston model. It has been around for a while.

Also, from my understanding, arbitrage free pricing theory does not mean that there is no arbitrage in the markets. The other way around, it is a good way to find arbitrage opportunities. Value an option (arbitrage free price) -> compare it to market price -> take into account other factors (incomplete markets, transaction costs) -> decide if arbitrage opportunity exists.

Also, if you are interested in new theory, I'd recommend you to read the Adaptive Market Hypothesis by Andrew Lo. It is a great read.
Click to expand...


Indeed, a very excellent read! I agree with AMH 100%! I hope you agree with my following observation: For pricing financial derivatives, one should a clear view of the relationship

EMH = Unique risk-neutral measure.

AMH = Risk-subjective measure.
 
A modest quant said:
What's your point here? Take a stand, state reasons! Don't be a bystander!
Click to expand...
I am taking a stand here. Black Schole's isn't "wrong" any more than it is "right". It's a useful model that begins to explain some of the reasons options are priced the way they are. Nothing more, nothing less.
 
euroazn said:
I am taking a stand here. Black Schole's isn't "wrong" any more than it is "right". It's a useful model that begins to explain some of the reasons options are priced the way they are. Nothing more, nothing less.
Click to expand...

Many many...many traders, including myself, never use BS formula or its model to price options because they don't need it and perhaps in fact it is useless and could be harmful. I happened to read Triana's book recommended by the Coolarbitrager in his/her post, evidence shown there are quite strong. I must say I incline to agree. I posed questions on usefulness of models in other posts. I'm now quite confident in understanding that financial market is not a place for physics, but is a place where traders agree on fair deals and the costs involved in obtaining them. Almost no laws of physics are used here. It's all about fair plays/deals. Remember that most of traders, like myself, do not have background in physics and we don't need it, yet we can make markets. :)
 
euroazn said:
I am taking a stand here. Black Schole's isn't "wrong" any more than it is "right". It's a useful model that begins to explain some of the reasons options are priced the way they are. Nothing more, nothing less.
Click to expand...

BS fits neatly into the neoliberal worldview of the last 30 years: that markets are like physical systems and have an underlying rationale of their own, which can be described mathematically. It therefore legitimised the explosive growth of derivative trading which had hitherto been seen as gambling. It has an ideological purpose rather than a scientific one. I don't think BS has ever been used to determine price based on historical volatility; rather, it's been used to explain price based on intangible "volatility." Could the world live without BS? Absolutely.
 
bigbadwolf said:
BS fits neatly into the neoliberal worldview of the last 30 years: that markets are like physical systems and have an underlying rationale of their own, which can be described mathematically. It therefore legitimised the explosive growth of derivative trading which had hitherto been seen as gambling. It has an ideological purpose rather than a scientific one. I don't think BS has ever been used to determine price based on historical volatility; rather, it's been used to explain price based on intangible "volatility." Could the world live without BS? Absolutely.
Click to expand...

Oh my God!...30 years of intangible implied "volatility", as an ambiguous measure of risk or uncertainty, would make us less intelligent in what we trade, even for vanillas. At least for vanillas without BS formula, we make their prices, we don't derive, so why do we need to understand prices?

After three decades of attempts at understanding "volatility", we trade less exotics than before, investors (non physics followers) shy away from risky structured derivatives. Too much risk at stake.

Agree with you. Indeed the world can live without BS. I know i do. I believe tt's time to let go BS formula and its theory. Models of physics are delusional comforts that academics and quants offer to the markets to the point anyone can ask: "What do we do without a model? Model is better than nothing!".

I strongly suggest we must ask ourselves: "What is good with a model if it is faulty, even deceptive with ambiguous parameters?". It is meaningless to ask if a model best fits market prices today, because today is tomorrow's history. We must ask if a model is useful and if it is built based on a rigorous framework of financial economics (assuming that we have one), not physics.

Physical world and financial world are two distinct parallel worlds. Is it the same rationale behind an apple falling from a tree and a drop in a stock price? I think not. We must use mathematics in a intelligent way and strike a balance between these two worlds. And importantly we must not perceive financial world as a physical one, and vice versa.
 
A modest quant said:
Oh my God!...30 years of intangible implied "volatility", as an ambiguous measure of risk or uncertainty, would make us less intelligent in what we trade, even for vanillas. At least for vanillas without BS formula, we make their prices, we don't derive, so why do we need to understand prices?

After three decades of attempts at understanding "volatility", we trade less exotics than before, investors (non physics followers) shy away from risky structured derivatives. Too much risk at stake.

Agree with you. Indeed the world can live without BS. I know i do. I believe tt's time to let go BS formula and its theory. Models of physics are delusional comforts that academics and quants offer to the markets to the point anyone can ask: "What do we do without a model? Model is better than nothing!".

I strongly suggest we must ask ourselves: "What is good with a model if it is faulty, even deceptive with ambiguous parameters?". It is meaningless to ask if a model best fits market prices today, because today is tomorrow's history. We must ask if a model is useful and if it is built based on a rigorous framework of financial economics (assuming that we have one), not physics.

Physical world and financial world are two distinct parallel worlds. Is it the same rationale behind an apple falling from a tree and a drop in a stock price? I think not. We must use mathematics in a intelligent way and strike a balance between these two worlds. And importantly we must not perceive financial world as a physical one, and vice versa.
Click to expand...

A modest quant has made very good valid points. Market is, market does!
 
BS is not a predictive model!! In these models guys are just saying "look, under some simplifications, we did some analysis and derived this.'' They aren't saying ''our model should be used to price every derivative in every situation'' as the OP is implying.

I don't think BS was meant to be taken so literally. Especially not crises... I mean the observed crises are impossible under Brownian Motion.
 
Well, the fact about the BS formula is that even when it is thought in school it is clearly described as an incomplete model. It is incomplete, and restrained by some strong assumptions, such as indeed, constant volatility, arbitrage theory, and even a finite number of states for a certain stock value. Nonetheless, the fact of the matter is this is the most widespread model we have. Sometimes, it is described as the best model we have, which I indeed disagree with as I believe we have better models that fit particular situations, but as long as most consider it valid, it will be used. And overall I have no problem with the formula in itself, it is a pretty simple model to introduce even someone in the second year like me to financial theory.
But of course, the model should not be taken as a given, one who is truly interested in using it, should just start with it, and study other models deriving from it that reflect better a certain stage of the market.
 
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