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Taylor, Black and Scholes : Series Approximations and Risk Management Pitfalls, Research Paper 9501

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Taylor, Black and Scholes : Series Approximations and Risk Management Pitfalls, Research Paper 9501

DATE: March 1995

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ABSTRACT: Risk managers make frequent use of finite Taylor approximations to option pricing formulas, particularly of first and second order (delta and gamma). This paper shows that for a plausible range of parameter values, the Taylor series for the Black-Scholes formula diverges. Using a numerical technique developed in the paper, it is also shown that even when the series converges, finite approximations of very large order are generally necessary to achieve acceptable levels of accuracy. Implications for risk management and stress testing are discussed.

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Estrella, Arturo. "Taylor, Black and Scholes : Series Approximations and Risk Management Pitfalls, Research Paper 9501," Research Papers (Federal Reserve Bank of New York) (March 1995). https://fraser.stlouisfed.org/title/6570/item/615487, accessed on March 29, 2023.

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SUBJECTS:

THEMES: CLASSIFICATION:
  • lcc: HG136 .F45 no.9501
IDENTIFIERS:
  • oclc: 32300028
  • repec: fip:fednrp:9501
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