Volatility says less about the future than accounting rules suggest

Schroeder, Gerhard (2006): Volatility says less about the future than accounting rules suggest. Forthcoming in: Accepted by the All China Economics International Conference Dec 18-20, 2006 in Hong Kong , Vol. n/a, No. ACE Conference Publication Submission No 1246 (March 2007): pp. 1-23.

Abstract

Both US and EU accounting rules are vague in referring to the Black-Scholes model or pricing models derived from B-S. They are wrong in treating volatility since the mathematical assumption of constant volatility does non apply. Back-testing proves that low performance is achieved in predicting underlying values. The formula of Black and Scholes (with volatility as a key variable) is derived from Einstein’s model explaining Brownian Motion. It is relatively far from market reality. Some disadvantages of the B-S model are explained. It remains risky to base investment decisions on these stochastic principles ex-clusively since that is then a matter of pure chance excluding any economic ra-tionale. Within the context of the capital market discipline, the intention is to both to suggest an economic analysis as well as to provide some inside experi-ence regarding market theory to accountants. The may be not aware of the model that are not reflected in guidance published by international accounting authorities. There is no economic rationale for making future values dependent on today's volatility. Using these models for evaluations means "creative" accounting. Themes: Financial Economics and Institutions, Monetary Policy.

• Item Type: MPRA Paper
• Language: English
• Keywords: IAS; accounting; fair value; stochastic pricing; Black-Scholes
• Subjects: F - International Economics > F3 - International Finance; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M4 - Accounting and Auditing > M41 - Accounting

References

Accounting Rules IAS39 (AG 74-82) / FAS 123R (SAB SEC-Staff Accounting Bulletin 107)