Good Point But Wrong Conclusions
"The genius of the Black-Scholes formula lies in its elegant distillation of all the unknowns involved in the valuation of a future contingent claim into a single parameter: volatility. This has allowed practitioners, all well aware of the initial model's shortcomings, to enhance the formula in simple and intuitive ways, thus preserving its tractability under less idealised assumptions. As a consequence, it has survived the myriad stress tests it has been subject to since its 1973 inception, thus remaining the pricing foundation upon which billions of dollars change hands every day in the derivatives markets"
Having made the same point myself several times, I can´t deny the wisdom of the above words (even if they are meant to contradict Taleb´s excellent truth-filled article). However, the reader forgets a couple of things: 1) Practitioners might not have been using BS at all (see Taleb&Haug), 2) Assuming that the model is in fact used, the volatility fudging is done PRECISELY because traders know that BS is very very wrong; thus, highlighting such fudging (which, yes, is a wonderful thing that has allowed the model to remain alive in spite of its unworldliness) as a justification for the model receiving the Nobel misses the point completely. In fact, the need for volatility fudging sends a very powerful message to the Nobel commitee: you rewarded a very unrealistic (though still useful) construct.
What this reader doesn´t seem to understand is that resorting to the existence of the vol smile in order to criticize Taleb´s take-no-prisioners all-out assault of finance theory is the most effective way to recognize the accuracy of Taleb´s musings.
As Haug might say: good points but wrong conclusion.
ptriana@profesor.ie.edu
