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Black-Scholes formula

  1. Mar 27, 2012 #1

    I understand that the normal distribution is used to model stock returns in the Black-Scholes formula.

    Can someone please tell me whether this is meant to be the subjective probability distribution or the risk-neutral probability distribution?

    Thank you!
  2. jcsd
  3. Mar 28, 2012 #2


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    risk neutral (assuming prices are continuous & the underlying can be sold short without limit)
  4. Mar 28, 2012 #3
    Thank you for your response! Can you perhaps point me to some academic sources?

    I read something that claims the implied volatility is an estimate of the variance of the subjective probability of asset return -- is that just because they are not drawing the distinction between subjective and risk-neutral?
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