Black-Scholes
TheoryDefinition
The 1973 mathematical model by Fischer Black, Myron Scholes, and (separately) Robert Merton that derives the theoretical price of European options. Won the 1997 Nobel Prize.
Inputs: stock price, strike, time to expiration, volatility, risk-free rate. Limitations: assumes constant volatility, no dividends, lognormal price returns, no early exercise. Real markets violate every assumption — practitioners use the model with corrections (vol smile, American-option adjustments, dividend handling).
Inputs: stock price, strike, time to expiration, volatility, risk-free rate. Limitations: assumes constant volatility, no dividends, lognormal price returns, no early exercise. Real markets violate every assumption — practitioners use the model with corrections (vol smile, American-option adjustments, dividend handling).