Yes you are correct MartinGhoul, the assumption behind the model is flawed, not the formula itself, that's what I meant, sorry for the confusion. Here are the 9 important flaws in the Black-Scholes option pricing model: http://voices.yahoo.com/9-important-flaws-black-scholes-pricing-model-11979528.html
You're kidding right?! That's the dumbest thing I've read today. It's a market. Best bid, best ask. There's been numerous people to price options according to a modified options model. John Bender I believe was a big one.
Even Fischer Black, one of the authors, says the model is flawed. Your can read his analysis about the holes at: http://www.scribd.com/doc/74806381/Holes-in-Black-Scholes There are many other papers available via Google outlining the many flaws in Black-Scholes. Black-Scholes is not currently used by any serious financial institution to model options. It is a useful academic and teaching tool.
I know all about the "holes" in B-S. The fact that a model is flawed doesn't make it less useful or wrong. Like in the example I've given before, the fact that classical mechanics-based view of the world isn't always applicable doesn't mean that Newton's laws are useless. Just because there's non-Euclidean geometry doesn't mean that traditional geometry is useless. In fact, and this is the case with B-S as well, all the less flawed models of the world owe their existence to the "flawed" ones that came before. And as to your last assertion, that's just plain silly and suggests to me that you have absolutely no idea what you're talking about. All option pricing done by any financial institution, in any asset class, no matter how sophisticated the technique, is based on Black-Scholes, one way or another.
On the Wall Street and in speculations on the stock market there is nothing new. what happened in the past will occur again, again and again. it occurs because the human nature doesn't change and human emotions always get in the way of human mind
It's doesn't make much difference how precise the formula is or even what it does. When credit is expanding for every dollar in the economy there are multiple of credits created leading to greater a number of investments. This causes the expansion and as credit histories become stronger due to increases in asset values. Now more credit becomes easily available to those whose assets are growing. As the expansion accelerates eventually the danger of inflation creeps in and the central bank tightening ensues. Now this makes borrowing or receiving credit a bit tougher for some. Then as tightening continues some marginal businesses are unable to pay those higher interest rates and have to liquidate their assets to get cash and pay the creditor. It's here things get interesting. The exotic formula of balancing assets or what not had been working admirably up to this point. In fact I would go as far and say the formula may be a work of genious and quite useful. The problem with the formula arises when the contraction and selling of assets for cash to pay back loans picks up steam. As asset prices due to selling begin to drop the credit histories become worse and attainment of more credit becomes very hard. Now due to this artificial credit creation that's multiples of the available cash, the credit loans are many times larger than the cash that is needed to pay back those loans. Almost all assets start losing value and the poor formula though accurate is insufficient to balance anything when the whole house of cards is crashing down. Had it been cash only loans and no credit expansion the formula most likely would have worked very well. In credit based expansion the formula leads a group into using the formula to optimize, and because of that optimization there's a buildup of assets which makes it a much more onerous task to get rid of these assets when the values crumble. In the end the formula isn't to blame. It's the credit creation and destruction that causes these boom and bust cycles. The poor fellow who came up with the formula gets lauded for his genious and then later gets blamed for leading to heavier than usual losses because of that very formula. Keep this in mind when another recession shows up. Eventually some formula or person will be blamed for the losses and the cycle will go on and on. History has been repeating itself quite regularly and only looks different on the surface. Gringo