Tuesday, March 8, 2011

Damodaran's view on Buffett's view of derivatives!!

Here i go... With the basic understanding of Black-Scholes' option pricing model which under value deep out of the money options and over values the options that are illiquid (as the pricing model assumes continuous prices); (Of course Damodaran too mentions the same), Prof presented a detailed critic of Buffett's recent statement that 'Black-Scholes wildly produces inappropriate values when applied to long-dated-options.

This illustration clarifies many nitty-gritties of B-S option pricing model! [Link]

Saturday, March 5, 2011

Damodarn on Equity risk premium!

[Link] Damodaran discusses on forward risk premium. Actually it is quite simple and you can have daily risk premium which reflects the current risk market experiences. The knowledge of which is very helpful for the fund manager. It is simple, calculated the today's return on security, by using the corresponding risk free rate, back out the risk premium!!

Of course, incorporating the everyday's risk and making the appropriate changes in the portfolio may be ideal, but it causes huge transaction costs. However, the knowledge of the same is helpful!!