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The Peculiar Logic of the Black-Scholes Model

Published online by Cambridge University Press:  01 January 2022

James Owen Weatherall
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Abstract

The Black-Scholes(-Merton) model of options pricing establishes a theoretical relationship between the “fair” price of an option and other parameters characterizing the option and prevailing market conditions. Here I discuss a common application of the model with the following striking feature: the (expected) output of analysis apparently contradicts one of the core assumptions of the model on which the analysis is based. I will present several attitudes one might take toward this situation and argue that it reveals ways in which a “broken” model can nonetheless provide useful (and tradeable) information.

Type
Research Article
Information
Philosophy of Science , Volume 85 , Issue 5 , December 2018 , pp. 1152 - 1163
Copyright
Copyright © The Philosophy of Science Association

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Footnotes

†

This article is partially based on work supported by the National Science Foundation under grant 1328172. I am grateful to the audience at PSA 2016 and to my cosymposiasts for helpful comments and discussion and to an audience at Cambridge History and Philosophy of Science for comments on a related talk.

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