I am currently reading a very interesting book by Jean-Philippe Bouchaud called “Theory of financial risks”. It is very recommended if you are mathematically inclined. The book tries to build option pricing from a different angle than the classical replication argument. These include assumption of continuous trading, constant volatility throughout the life of the option and log-normal returns.
In the last post, I have already displayed some graphs showing how the returns do not adhere to a normal distribution but to a skewed distribution with fatter tails. The point of the authors is that if in the Black and Scholes world, perfect replication is possible and hence no risk is involved, why do these instruments exist in the first place? The replication argument is so elegant that sometimes we forget to ask ourselves the most important questions. I used to ponder the same question myself from time to time. The answer probably lies somewhere in the middle. The markets are not in total chaos but nor are they complete.
The book develops a model for pricing options from a different angle, where there is no perfect hedge. The Black and Scholes world is just a pathological case i.e the exception and nothing more.
If you liked this post, buy me a beer
Beautiful teen girls
www.porntubebestmovies3.tk
I am new to options, and I was curious about the normal distribution you mentioned in the post. Are there any good numerical methods for estimating what the distribution looks like given recent historical price data as opposed to assuming it is just a normal distribution?
Hi! Are you ignoring my success ownership I have a good fresh joke for you! Where does a one-armed man shop? At a second hand store.