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. ^^^^^^ CB: It would seem that Wall Street as a whole wouldn't lose money. Any money "lost" would mainly be to "each other", among Wallstreeters. Wallstreet as a whole never loses money nowadays, does it ?
