Question

Critically assess the disadvantages of the Black Scholes Pricing Model on the Stock Exchange of Mauritius.

Answer 1

The following are the disadvantage of black scholes model on the stock exchange of Mauritius:

1. It assumes constant risk free returns which is not valid.

2. The assumption of constant volatility is wrong in stock exchange the volatility keeps on changing.

3. It assumes that option cannot be early exercised while in stock market many of the trader exercise early rather than holding till maturity.

4.It ignoes the dividend payout and it's affects on the stock which is not valid.

5. It doesn't consider large ups and down in the price of stock market, which happens too frequently in Mauritius stock exchange.

6. It also consider that there is no arbitrage opportunity but this is not correct.