By Ian Stewart – It was the holy grail of investors. The Black-Scholes equation, brainchild of economists Fischer Black and Myron Scholes, provided a rational way to price a financial contract when it still had time to run. It was like buying or selling a bet on a horse, halfway through the race.
The equation itself wasn’t the real problem. It was useful, it was precise, and its limitations were clearly stated. It provided an industry-standard method to assess the likely value of a financial derivative.
The formula was fine if you used it sensibly and abandoned it when market conditions weren’t appropriate. The trouble was its potential for abuse. It allowed derivatives to become commodities that could be traded in their own right. The financial sector called it the Midas Formula and saw it as a recipe for making everything turn to gold. But the markets forgot how the story of King Midas ended. more> http://is.gd/WINJ6B
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