The B&S equation presumes that past volatility has predictive power. i never understood why it should be so. Yet I made some money using it till about four years ago when realized that it stopped working. Looking back, it is incredible how eveybody believed that future could be calculated precisely. Many still do.
I think that the stock market is a battleground, setting minds against cheating minds. My ethanol-fueled mind cannot out-think those genius giants fighting for their lives on the field, so the outcome is unknowable. To me, at least.
10 comments:
The Black-Scholes equation is an approximate description of reality limited to certain market conditions. It's not flat-out wrong.
In certain market conditions it is flat out wrong. Moreover, say you bet one year's savings on it predictive strength and lost, it is flat out wrongissimo.
The usual Black-Scholes option pricing formula applies to the price of a European option, not an American option. Look up Black-Scholes in Wikipedia. With a European option you can only exercise the price at the expiration date. With an American option you can do that any time before.
Then the theory has to be revised for volatility smiles, which started after the crash of 1987.
Option pricing theory replaces one unknown, the price, with another, the volatility. But volatility is more predictable than price.
Finally one failure does not negate a theory based on probability. That one failure might just have been bad luck.
BTW are you familiar with the Kelly Criterion?
We would like to have a word with the German Finance Minister.
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9077586/Germanys-Carthaginian-terms-for-Greece.html
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/9077586/Germanys-Carthaginian-terms-for-Greece.html
It is certainly arguable Greece has no hope of clawing back viability within monetary union and should therefore return to the Drachma.
While Ireland has pulled off an “internal devaluation” inside EMU by deflating wages, it has an open economy, a high trade gearing, and a current account surplus: Greece has a deficit of 9.4pc of GDP after four years of slump. Greece’s “equilibrium real exchange rate” is overvalued by 33pc according to IMF data.
But that is not the argument made by Mr Schäuble. As high priest of the “household fallacy” - the false equation of macro-economics with the budget of a Schwabian Hausfrau - he thinks Greece is in trouble because it spends too much, not because it is trapped in debt deflation with a badly over-valued currency.
From there he progresses to the next fallacy of thinking that Portugal, Spain, and Italy will pull through as long as they cut, cut, and cut again.
If Portugal spirals down in much the same fashion as Greece once austerity bites in earnest - and therefore misses target after target - it is likely that Mr Schäuble will turn on Portugal with equal fury, because that is how he sees the world.
Each failure is ascribed to lack of moral fibre, not to the design flaws in the currency project that he himself helped create and foist on the German people against their wishes.
Belief that EMU fall-out from Greek exit - or “Grexit” in market slang - can be contained by firewalls and more fiscal austerity assumes that Greece is a special case, alone brought low by turpitude.
If you think, as I do, that Greece did indeed commit a host of sins but is also the first of several victims of a mad ideological experiment that shackled together economies with different growth rates, wage bargaining systems, productivity patterns, sensitivity to interest rates, and inflation proclivities - without fiscal transfers or sufficient labour mobility to cushion the effects - and that this disaster was compounded by Germany’s (beggar-thy-EMU-neighbour?) wage squeeze, and compounded yet further by sharp monetary and fiscal contraction at the wrong moment in the states most at risk, then you will expect the crisis to grind on whatever happens in Greece.
The EMU end-game is harrowing for Greece, but it is also ghastly for Germany. Berlin has accumulated ruinous liabilities without yet solving anything, and is fast squandering sixty years of diligent statecraft.
By demanding a budget viceroy for Greece, and now an escrow account to seize Greek revenues at source, the Merkel-Schäuble government has crossed a diplomatic line and brutalised EU politics. “Memorandum Macht Frei”, as one Greek newspaper splashed.
I do not, however, think that Fisher Black was responsible for Greece.
Anon.
I doubt that most people who could understand the equations were taken in by the seeming certainty of the results. What they liked about the BS and other such mathematical artifacts is that they enabled one to put a number on the trade. This gives everyone the illusion of certainty and thus everyone could get their bonuses and go home. For the Black Scholes, to work the assumptions have to hold. The main ones seem to be the Random Market Hypothesis, a deep and broad pool of buyers on both sides of the market and the assumption of a continuum of prices. None of these conditions hold for any length of time in the face of massive movements. In engineering, everyone knows that the differential equations are only valid given the assumptions, but second and third order financial engineering is not designed to do anything noble like protecting the customer or the integrity of financial markets. It exists simply to fool both the practitioners and customers alike with the illusion of control. And in the hands of vultures - all too common in the finance industry - it is one more tool to fleece the customers and fool the regulators.
Ivan
The Germans should have the self-assurance to boot out free loading Greeks without looking over their shoulders for Hitler's shadow. The Greeks should live by the principle that they never pay for goods already delivered. Each should live according to his lights. This makes for a much happier life.
Ivan
In America, all white people are supposed to atone for the guilt of the Southern slavers, even though slavery was abolished 150 years ago. How long will the Germans be required to feel guilty for the acts of the Nazis?
The Greek freeloaders scream and yell like stuck pigs, but the Germans have already given amply and have no obligation to give any more, certainly not on account of Adolf. If the Germans now have zero trust in the Greeks, it is for amply good reason - the Greeks lied (a tautology)like crazy to get into the currency union and there is no reason to think that (despite the parliamentary approval) that they will be any more trustworthy in the future.
I think the better course would be to write the Greek debt down 100% and cast them loose. No point in putting good money after bad. The 30% of the debt that remains won't get paid anymore than the last 70% - be realisitic - they ain't paying nuthin'. Let the market determine the worth of the drachma and let's all enjoy cheap vacations in Greece again. The Greeks will have the living standard they deserve for the work that they actually do - somewhere on the level of Albania or Bulgaria. If the Greeks want to cheat on their taxes or all work for the railroad or retire at 52 or whatever, it will be their own problem, not the Germans and not anyone else.
K
"How long will the Germans be required to feel guilty for the acts of the Nazis?"
Until the sun burns out.
Anon.
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