Black-Scholes-Merton (BSM) option pricing model is one of the most important and widely used models in finance. It has been used to price a wide variety of options, including stock options, bond options, and foreign exchange options. The
BSM model is based on a number of assumptions, including the assumption that
asset prices follow a
geometric Brownian motion.
The preprint you linked to argues that there are mathematical mistakes in the BSM model. If these mistakes are correct, it could have implications for a number of strands of the economic literature. For example, the BSM model has been used to study the relationship between
stock prices and volatility, the impact of
option prices, and the pricing of options on assets that do not follow a geometric Brownian motion.
If the findings are correct, it could lead to a rethinking of a number of
economic theories that rely on the
Here are some of the main economic theories that use the
BSM model or Merton's budget equation:
Portfolio theory: Portfolio theory is the study of how to construct and manage a
portfolio of assets. The BSM model is often used to calculate the value of a portfolio of options.
Risk management: Risk management is the process of identifying, measuring, and managing risks. The BSM model is often used to calculate the risk of an option position.
Corporate finance: Corporate finance is the study of how to raise and manage capital for a business. The BSM model is often used to calculate the value of a corporate option, such as a call option on a stock or a put option on a bond.
It is important to note that the BSM model is not without its limitations. For example, the model assumes that asset prices follow a geometric Brownian motion, which is not always the case. Additionally, the model does not take into account factors such as dividends, interest rates, and transaction costs.
Despite its limitations, the BSM model is a powerful tool that can be used to price a wide variety of options. If the findings of the preprint are correct, it could lead to a rethinking of the BSM model and its use in economics