Which of the following statements about the Black-Scholes Model (BSM) is most likely true?

Question

BlackTom AI · Accepted Answer

When evaluating statements about the Black-Scholes Model (BSM), it's important to ground each option in the core assumptions of the model.
Option A: The idea that trading occurs in discrete time is inconsistent with the BSM, which is formulated in continuous time using stochastic calculus. This makes A incorrect since BSM relies on continuous-time dynamics for the underlying price.
Option B: The BSM does not incorporate market frictions such as transaction costs, bid-ask spreads, or liquidity constraints. It assumes a frictionless market, so B is false because the model abstracts away these real-world frictions.
Option C: The baseline BSM framework assumes no dividends on the underlying stock, or it incorporates a known dividend yield as an extension, but the classic form without modifications does not assume dividend-paying. Therefore C is misleading as stated for the standard BSM.
Option D: The statement that the BSM assumes the stock price follows a log-normal distribution is consistent with the model’s core assumption: the logarithm of stock prices is normally distributed under the risk-neutral measure, leading to a log-normal distribution for the price itself. This aligns with the fundamental property used in BSM option pricing.
In summary, A and B mischaracterize the model’s time framework and frictions, C misstates the basic dividend assumption in the standard form, while D correctly reflects the log-normal price distribution implied by the BSM framework.

Which of the following statements about the Black-Scholes Model (BSM) is most likely true?

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