ON APPLICABILITY OF BLACK-SCHOLES MODEL TO MSE

Abstract

Abstract In this paper we test the accuracy of assumptions of Brownian motion model for stock pricing
process for the Macedonian Stock Exchange (MSE) ), which serves as an example of an emerging incomplete
market. For this purpose we use historical prices data for three traded companies on the MSE with the
highest market capitalisation: Alkaloid (ALK), Makpetrol (MPT) and Komercijalna banka (KMB). We also
evaluate the accuracy of Black-Scholes (BS) options pricing model for stocks traded on MSE. For this
purpose we define a hypothetical trader whose investment strategy is to buy a fixed number of options every
day. Our analysis proves that BS model is not suitable for evaluation of out-of-money options on incomplete
markets since the assumptions of its underlying stock pricing process model are not satisfied. The BS model
has limited value only for in-the-money options whose value is not significantly overestimated by leptokurtic
nature of the distribution of daily returns.
Key words Financial Derivatives, Options, Black-Scholes Formula