Comparison and Analysis of the Effectiveness of the State-of-the-Art in Option and Financial Pricing Models

Abstract

Contemporarily, various models have been developed and used to price the returns of an asset or an option for decades. This paper will discuss and compare two option pricing models (the BSM model and the Monte Carlo Simulation) and three financial pricing models (the CAPM, the FF3 Model, and the FF5 Model). It will start with discussing the history, assumptions, and formulae of each model. Then, it will lead into how each model has changed over time, whether that be changes from the researchers themselves or other researchers within the community. Additionally, specifics of the change will be addressed, and the paper will outline what the new model has done to improve upon those concerns. Eventually, an empirical comparison will contrast the effectiveness and accuracy of each model. Ultimately, it will be seen that the BSM model and the MCS are useful in different time frames and the FF5 model is superior to the original financial pricing models as it builds on the original models’ limitations. Even so, the BSM model, MCS, and the FF5 model still have their own limitations that vary from reality and can be improved on in future research. These results shed light on guiding further exploration of newer and more refined models, methodologies, and approaches aimed to enhance our ability to make informed decisions and manage risks with greater precision.