Derman and Taleb's ‘The illusions of dynamic replication’: a comment

Ruffino, Doriana; Treussard, Jonathan

doi:10.1080/14697680600868283

Cited by 6 publications

(4 citation statements)

References 11 publications

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“…Traders at New York stock exchange specializing in using the put-call parity to convert puts into calls or calls into puts was at that time known as Converters, Reinach (1961): 12 The argument of Derman and Taleb (2005) was present in Taleb (1997) but remained unnoticed. 13 Ruffino and Treussard (2006) accept that one could have solved the risk-premium by happenstance, not realizing that put-call parity was so extensively used in history. But they find it insufficient.…”

Section: Myth 1: People Did Not Properly "Price" Options Before the Bmentioning

confidence: 97%

Option traders use (very) sophisticated heuristics, never the Black–Scholes–Merton formula

Haug

Taleb

2011

Journal of Economic Behavior & Organization

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a b s t r a c tOption traders use a heuristically derived pricing formula which they adapt by fudging and changing the tails and skewness by varying one parameter, the standard deviation of a Gaussian. Such formula is popularly called "Black-Scholes-Merton" owing to an attributed eponymous discovery (though changing the standard deviation parameter is in contradiction with it). However, we have historical evidence that: (1) the said Black, Scholes and Merton did not invent any formula, just found an argument to make a well known (and used) formula compatible with the economics establishment, by removing the "risk" parameter through "dynamic hedging", (2) option traders use (and evidently have used since 1902) sophisticated heuristics and tricks more compatible with the previous versions of the formula of Louis Bachelier and Edward O. Thorp (that allow a broad choice of probability distributions) and removed the risk parameter using put-call parity, (3) option traders did not use the Black-Scholes-Merton formula or similar formulas after 1973 but continued their bottom-up heuristics more robust to the high impact rare event. The paper draws on historical trading methods and 19th and early 20th century references ignored by the finance literature. It is time to stop using the wrong designation for option pricing.

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Section: Myth 1: People Did Not Properly "Price" Options Before the Bmentioning

confidence: 97%

Option traders use (very) sophisticated heuristics, never the Black–Scholes–Merton formula

Haug

Taleb

2011

Journal of Economic Behavior & Organization

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“…There have been a couple of predecessors to the present thesis that Put‐Call Parity is sufficient constraint to enforce some structure at the level of the mean of the underlying distribution, such as Derman and Taleb (), Haug and Taleb (). These approaches were heuristic, robust though deemed hand‐waving (Ruffino and Treussard, ). In addition they showed that operators need to use the risk‐neutral mean.…”

Section: Introductionmentioning

confidence: 99%

Unique Option Pricing Measure with neither Dynamic Hedging nor Complete Markets

Taleb¹

2015

Euro Fin Management

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Proof that under simple assumptions, such as constraints of Put-Call Parity, the probability measure for the valuation of a European option has the mean derived from the forward price which can, but does not have to be the risk-neutral one, under any general probability distribution, bypassing the Black-Scholes-Merton dynamic hedging argument, and without the requirement of complete markets and other strong assumptions. We confirm that the heuristics used by traders for centuries are both more robust, more consistent, and more rigorous than held in the economics literature. We also show that options can be priced using infinite variance (finite mean) distributions.

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“…Andreasen, Jensen and Poulsen (1998) is an account of some of them; Derman and Taleb (2005) is a recent (although debatable, see Ruffino and Treussard (2006)) addition.…”

Section: Introductionmentioning

confidence: 99%

Four Things You Might Not Know About the Black-Scholes Formula

Poulsen¹

2007

JOD

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Derman and Taleb's ‘The illusions of dynamic replication’: a comment

Cited by 6 publications

References 11 publications

Option traders use (very) sophisticated heuristics, never the Black–Scholes–Merton formula

Option traders use (very) sophisticated heuristics, never the Black–Scholes–Merton formula

Unique Option Pricing Measure with neither Dynamic Hedging nor Complete Markets

Four Things You Might Not Know About the Black-Scholes Formula

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