Which of the following assumptions made in deriving the Black-Scholes formula are commonly violated in the real world?
A) Log-returns are normally distributed.
B) The volatility of the stock is constant.
C) Prices evolve continuously, i.e., there are no market "gaps."
D) All of the above.

Question

Quizplus · Accepted Answer

All three assumptions (normal distribution of log-returns, constant volatility, and continuous price evolution) are commonly violated in the real world. In reality, asset returns often exhibit fat tails and skewness, volatility is generally not constant, and prices can experience large gaps or jumps due to news events or other external factors. These violations can lead to errors and inaccuracies in the Black-Scholes model and affect the validity of the formula's results.

Which of the Following Assumptions Made in Deriving the Black-Scholes