Which of the following is a limitation of using the Black model to price interest rate...
Which of the following is a limitation of using the Black model to price interest rate options?
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a. the risk-free rate is not constant |
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B. the volatility is not constant |
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C. interest rates are not lognormally distributed |
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D. all of the above |
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E. none of the above |
Homework Answers
D: all of the above
The Black Scholes model assumes constant risk free rate and volatility which will not be so in the real world. Moreover the interest rates are not lognormally distributed in reality. This is an assumption in the model since asset prices cannot be negative.
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