Black-Scholes pricing rests on idealized no-friction market assumptions.

Evidence

In their paper on the theory of option pricing, Black and Scholes spelled out their assumptions. These included not just the basic assumption that the “stock price follows a [log-normal] random walk in continuous time,” but also assumptions about market conditions: that there are “no transaction costs in buying or selling the stock or the option”; that it is “possible to borrow any fraction of the price of a security to buy it or to hold it,” at the riskless rate of interest; and that there are “no penalties to short selling” (Black and Scholes 1973, p. — Donald MacKenzie, An Engine, Not a Camera, 627

Categorization

• DEFINE: Spells out the core idealizing assumptions behind the model — the assumptions that make the pricing formula tractable.
• XREF: These frictions (transaction costs, credit constraints, short-selling penalties) connect to the law-merchant literature on how institutions overcome market frictions. — connects to: Finance theory’s core models assume frictionless markets with no transaction costs or short-selling penalties — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 51; The Black-Scholes formula contains no risk parameter, implying risk-neutral pricing. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 598; Black-Scholes assumes away the price gaps that would break its hedging strategy. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 805 (+1 more)

Broader Connections

• Black-Scholes assumes away the price gaps that would break its hedging strategy. #exemplifies (0.95) — Donald MacKenzie, An Engine, Not a Camera, 805
• The model’s assumptions became more realistic as markets restructured around it #exemplifies (0.90) — Donald MacKenzie, An Engine, Not a Camera, 741