Why does black and scholes formula for pricing options use risk free rate?

BS constructs a perfectly hedged portfolio. "Perfectly hedged" means "risk-free." A risk free portfolio grows at the risk free rate.
A rule of thumb is to use the US Treasury or libor as a proxy, but a more accurate method is to price OIS interest rate swap. Overnights eliminate almost all counterparty, political, and other risks

Answer by Lance Diduck:

BS constructs a perfectly hedged portfolio. "Perfectly hedged" means "risk-free." A risk free portfolio grows at the risk free rate.
A rule of thumb is to use the US Treasury or libor as a proxy, but a more accurate method is to price OIS interest rate swap. Overnights eliminate almost all counterparty, political, and other risks

Why does black and scholes formula for pricing options use risk free rate?

Advertisements

Leave a comment

Filed under Life

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s