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The Black-Scholes Formula: A Documentary

Tue, 13 Mar 2012 15:37:00 GMT

This documentary from the BBC's Horizon program charts the history behind perhaps the most important formula in finance: the Black-Scholes-Merton options pricing model. Two of its creators were awarded the Nobel Prize in Economics in 1997 and only a year later their hedge fund Long Term Capital Management (LTCM) had collapsed with staggering losses of $100 billion due to significant leverage of the strategy.

The Black-Scholes Formula was derived by observing that an investor can precisely replicate the payoff to a call option by buying the underlying stock and financing part of the stock purchase by borrowing. Only five variables were needed: the price of the stock; the exercise price of the option; the risk-free interest rate; and the time to maturity of the option. The only unobservable is the volatility of the underlying stock price...

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