Pricing theory tells us how much a derivative is worth. While it is based on principles that any rational person would adhere to, it may be the most complex thing in all of finance. On the other hand, it may not be.
It's all Greek to me.
A theory can be proved by experiments; but no path leads from experiment to the birth of a theory.
Order and Simplification are the first steps toward the mastery of a subject - the actual enemy is the unknown.
A precedent embalms a principle.
The Great Principles on which we will build this business are as everlasting as the Pyramids.
Rationalism is an adventure in the clarification of thought.
A good part of the pricing is about sticking a wet finger in the air, and hoping you get it right.
Good theories, like Black-Scholes, provide a theoretical laboratory in which you can explore the effect of possible causes. They give you a common language with which to quantify and communicate your feelings about value.
Emanuel Derman,
The Journal of Derivatives, Winter 2000, p. 64
Last updated: January 9, 2011