Assumptions commonly made in pricing models

◈ Increased realism leads to increased complexity
◈ The more money, the better
- Need to keep rebalancing one’s portfolio in order to gain money.
- Can money really buy job satisfaction or happiness? There is opportunity
cost associated with gaining money (your time, energy, family, friends, etc.).
Is it really good for your soul to be occupied with money only every moment
of your life? Would you be more interested in work other than investment?
◈ Efficient market with perfect information (no un-symmetric or insider
information)
- Market at equilibrium and hence no arbitrage opportunity
◈ There is a commonly-agreed and known risk-free interest rate
◈ Price is continuous
◈ Trading is instantaneous and continuous (no stale prices)
◈ No transaction costs or taxes (Tax and death are two certainties in your
life)
◈ Settled transactions are reflected in the proceeds immediately
- No restrictive rules (such as short proceeds can be totally available for use
immediately)
◈ Log-normal stock price movement
- Leads to analytic simplicity
◈ Etc.