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Updated: May 10, 2025
It affects our minds, we know that it exists and we affect it in return. Our choices and actions irreversibly alter the state of the system. This altered state, in turn, affects our minds. This interaction IS what we call "reality". With the advent of stochastic and quantum virtual reality generators the distinction between "real" and "virtual" will fade. The Matrix thus is not impossible.
An equally important issue involves "risk smoothing". Risks, by nature, are "punctuated" stochastic and catastrophic. Finite insurance involves long term, fixed premium, contracts between a primary insurer and his re-insurer. The contract also stipulates the maximum claim within the life of the arrangement.
The folly of this argument lies in the fact that stochastic volatility contradicts the assumption required by the B-S model if volatilities do change stochastically through time, the Black-Scholes formula is no longer the correct pricing formula and an implied volatility derived from the Black-Scholes formula provides no new information."
Black-Scholes tackles stochastic volatility poorly. The formula also unrealistically assumes that the market dickers continuously, ignoring transaction costs and institutional constraints. No wonder that traders use Black-Scholes as a heuristic rather than a price-setting formula. Volatility also decreases in administered markets and over different spans of time.
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