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To: Lizzie Tudor who wrote (179960)12/20/2004 4:40:24 PM
From: GVTucker  Read Replies (3) of 186894
 
Lizzie, RE: Frontline had a whole piece on how BS caused the LCTM debacle which threatened to take down the mkts years ago.

I agree with you that options expensing foes are throwing up whatever red herrings they can find to support their bias, but to imply there isn't any reason to question BS is a bit naive don't you think?

I remember the end of that frontline piece, they had these analysts making statements that were essentially (paraphrasing)..."if you have a financial model and it fails to anticipate extreme events, ok, the model may or may not fail in totality.... but if you have a financial model DESIGNED to interpret extreme events and it fails, you have a failed financial model".

It was a good show, you might want to rent it


Here is a transcript from that entire Frontline episode back in 1999:

pbs.org

Black-Scholes is never mentioned. Why? Because Black-Scholes had nothing to do with LTCM.

LTCM failed because they had heavily levered positions on different fixed income securities that eventually would be the same value when the securities matured. LTCM didn't anticipate the volatility before maturity, though, and their leverage was so heavy that the equity went negative. Options pricing didn't have anything to do with it.

As I said, I have yet to see anyone offer any evidence that Black-Scholes isn't highly accurate. This is a perfect example. Black-Scholes is an equity option pricing model. LTCM was a fixed income leveraged hedge fund. They had nothing to do with each other.
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