What is the Black-Scholes model?

The Black–Scholes /ˌblæk ˈʃoʊlz/ or Black–Scholes–Merton model is a mathematical model for the dynamics of a financial market containing derivative investment instruments.

What is the Black–Scholes equation?

Further, the Black–Scholes equation, a partial differential equation that governs the price of the option, enables pricing using numerical methods when an explicit formula is not possible.

What are the assumptions of the Black-Scholes theory?

The Black-Scholes theory incorporates this assumption. Black-Scholes model assumptions are as follows. Black-Scholes theory assumes that option prices exhibit Brownian motion. The model assumes that risk-free rates are constant. In reality, they are dynamic—they fluctuate with supply and demand.

Are the assumptions of the Black–Scholes model empirically valid?

The assumptions of the Black–Scholes model are not all empirically valid. The model is widely employed as a useful approximation to reality, but proper application requires understanding its limitations – blindly following the model exposes the user to unexpected risk. Among the most significant limitations are: