Volatility says less about the future than accounting rules suggest

Back in 2006 I wrote this paper on accounting rules in the US and the EU which use "theoretical" valuations rather than market pricing. Annual reports using such asset valuations are no longer "readable" for outsiders.

Abstract:

Both US and EU accounting rules are vague in referring to the Black-Scholes model or pricing models derived from B-S. They are wrong in treating volatility since the mathematical assumption of constant volatility does not apply.

Back-testing proves that low performance is achieved in predicting underlying values. The formula of Black and Scholes (with volatility as a key variable) is derived from Einstein’s model explaining Brownian Motion. It is relatively far from market reality. Some disadvantages of the B-S model are explained.

It remains risky to base investment decisions on these stochastic principles ex-clusively since that is then a matter of pure chance excluding any economic ra-tionale. Within the context of the capital market discipline, the intention is to both to suggest an economic analysis as well as to provide some inside experi-ence regarding market theory to accountants. The may be not aware of the model that are not reflected in guidance published by international accounting authorities. There is no economic rationale for making future values dependent on today's volatility. Using these models for evaluations means "creative" accounting. Themes: Financial Economics and Institutions, Monetary Policy.

The full paper can be found here.

Systematics of Advanced Capital Market Models based on Empirical Research

Article published in Dec 2005. Here is the abstract:
The complex blue prints of ODE and PDE based capital market models remain closed to systematic review. Particularly, when some authors of mathematical models can not or may not offer explicit solutions. Artificially generated 'cloned' courses can demonstrate the impact of various types of stochastic volatility in these cases. The Black and Scholes formula has the disadvantage that its key variable, the (future) volatility. is not known. In fact, what is known is that the volatility is volatile itself and the assumption of a stable volatility is violated. The socalled advanced models try to model the stochastic volatility. However, this still implies assumptions how a particular volatility may (or may not) develope until a given point of time. An analysis of key indexes shows stochastic properties difficult to cover in mathematical models yet being still interesting.
Please find the full article here.

Stochastic Pricing

This is the first article I published at RePec / IDEAS.

Criticism regarding the Black and Scholes model isn't new. The model was about to be labeled 'historic'. It is new now that the model has become an autonomous, unreflected item in international accounting standards and law allowing "creative" accounting. There is no economial relation between the future value of an underlying and it's current volatility. Predictions - pricing of derivatives means predicting - remain uncertain. Findings are based on empirical, experimental techniques using fictituous derivatives, others.
Please check out the full article here.

Empirical Contributions to Optionpricing analyzing Black and Scholes and other Models

Another article of the series 2005 / 2006. By analyzing fictitious options - a unique approach - significant mispricing due to the formula of Black and Scholes can be shown systematically and independent from market distortion. Even options based on fictitious, lognormally distributed courses are not valued properly. According to the Law of Large Numbers pricing models based on time distibutions should be applied to strategies rather than to single option prices. The discontinuity of autocorrelation (Stalagmites Effect) has impact on forecasting models. The current impact of volatility - there is no - on option pricing is not justified.


For more download the article from this page.