The Black-Scholes equation excludes expected returns and risk aversion entirely

Evidence

However, the emerging new breed of financial economists quickly saw the elegance of the Black-Scholes-Merton solution. The expected return on the underlying stock and investors’ levels of risk aversion did not appear in the Black-Scholes equation: their arbitrage-based arguments did not require knowledge of those. Herbert Simon’s jibe that finance was a field dependent on unobservable variables seemed to have been answered decisively, at least as far as expected returns and risk aversion were concerned. — Donald MacKenzie, An Engine, Not a Camera, 610

Categorization

• XREF: This is the core hook of the performativity thesis — an arbitrage-based model that needs no knowledge of tastes or expectations, which the performativity literature builds on heavily. — connects to: Unobservable volatility means the Black-Scholes-Merton model has no unique predicted price. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 102; Pre-Black-Scholes option theory always hinged on unobservable expected returns. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 541; The Black-Scholes formula contains no risk parameter, implying risk-neutral pricing. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 598 (+2 more)

Broader Connections

• Pre-Black-Scholes option valuation needed investor risk attitude as an unobservable input #expands (0.90) — Donald MacKenzie, An Engine, Not a Camera, 536
• The arbitrage argument produces the Black-Scholes partial differential equation. #expands (0.75) — Donald MacKenzie & Yuval Millo, Constructing a Market, Performing Theory, 95