Black-Scholes Limitations

Black-Scholes Limitations

Intuition Publishing Pty Ltd
Updated Sep 24, 2020

The Black-Scholes model has a number of limitations when used to price some types of options. It cannot be used for American-style, or path dependent options, so different numerical approaches have been developed to price these options. Here we give a brief overview of binomial trees and Monte Carlo Simulation as methods of option valuation, explain the reasons behind the shortcomings of the Black-Scholes approach, and introduce the concept of the volatility surface.