On 12/28/06, Michael Perelman <[EMAIL PROTECTED]> wrote:
MacKenzie, Donald A. 2006. An Engine, Not a Camera (Cambridge: MIT
Press).
He tells this story very well. But then he explains how the players
discovered its limits.
Speaking of Black-Scholes limitations, Fischer Black was said to have
been astonished at the extensive use of their formula on Wall Street,
because he regarded the continuous time and log-normal price
assumptions as unrealistic. There is also significant evidence that
the Black-Scholes price became a self-fulfilling prophesy, and later
when the binomial pricing was introduced, THAT formula quickly became
the new self-fulfilling prophesy. See for e.g.
"Options markets, self-fulfilling prophecies, and implied volatilities"
Cherian, Jarrow et al., 1998
The big question is why was Wall St so eager to adopt unproven
formulas based on questionable assumptions. Why were they not scared
of losing money? How indeed did they avoid losing money?
-raghu.
