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Feb 28, 2009


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Buffett's criticism of Black-Scholes should draw attention. Buffett assumes that markets & stocks on average will increase over time, while Black-Scholes assumes on average, NO CHANGE, that variations in stocks are a pure 'random walk'. Volatility is the only measure B-S uses to model variation. Sounds like an arbitrage opportunity. Buffett's example of 100-yr derivative contracts on the S&P is a very simple example.

Ed Cone

One of the smartest guys I ever interviewed is credited with making Black-Scholes work in the real world. He was a conservative investor and a risk-manager who was talking a decade ago about many of today's topics, from outlier events (aka black swans) to stress testing for banks. A big part of the problem was putting these tools in irresponsible hands.


I would bet Struve made his money when B-S yielded mispricing of options. "He starts with Black-Scholes and returns frequently to a chart showing the relative rate of return of stocks and bonds over the last four decades," The fact he uses relative rate of return over 40 years means he deviates somewhat from the pure B-S equation. B-S assumes stock prices will be, on average, constant over any time period - the expected value of a stock at times t1 & t2 are the same.

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