The Black–Scholes–Merton Model

Robert Jarrow () and Arkadev Chatterjea

Chapter 19 in An Introduction to Derivative Securities, Financial Markets, and Risk Management, 2024, pp 419-458 from World Scientific Publishing Co. Pte. Ltd.

Abstract: The following sections are included:IntroductionNobel Prize–Winning Works (1973)The AssumptionsEXTENSION 19.1: Bubbles and Option PricingThe Pricing and Hedging ArgumentThe Black–Scholes–Merton FormulaUnderstanding the Black–Scholes–Merton ModelStock Prices and MartingalesRisk-Neutral ValuationActual versus Pseudo-probabilitiesThe GreeksInterpreting the GreeksSome Road Bumps AheadEXTENSION 19.2: Market Manipulation and Option PricingThe InputsObservable InputsVolatility: The Elusive InputExtending the Black–Scholes–Merton ModelAdjusting for DividendsForeign Currency OptionsValuing American OptionsEXTENSION 19.3: Exotic OptionsSummaryAppendixModeling the Stock Price EvolutionContinuously Compounded (Logarithmic) ReturnIntroducing UncertaintyThe Central Limit TheoremFirst Derivation of the Black–Scholes–Merton Formula (as a Limit of the Binomial Model)Second Derivation of the Black–Scholes–Merton Formula (Using Risk-Neutral Valuation)The Probabilities and the Risk PremiumProof of (24)CasesQuestions and Problems

Keywords: Derivatives; Financial Markets; Risk Management; Arbitrage; Financial Engineering; Forwards; Futures; Call Options; Put Options; European Options; American Options; Swaps; Currency Swaps; Interest Rate Swaps; Commodity Swaps; Equity Swaps; Credit Default Swaps; Commodity Derivatives; Equity Derivatives; Index Derivatives; Interest Rate Derivatives; Commodities; Margins and Daily Settlements; Binomial Model; Black-Scholes Model; Black-Scholes-Merton Model; Delta Hedging; Gamma Hedging; Heath-Jarrow-Morton Model; Libor Model; Forward Rate Agreements; Interest Rate Futures; Interest Rate Options; Market Manipulation; Regulation; Derivatives Exchanges (search for similar items in EconPapers)
JEL-codes: C58 G1 G10 G13 G2 G20 G32 (search for similar items in EconPapers)
Date: 2024
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