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A Matter of Liquidity: Why the Black-Scholes Model Over-Values Conversion Options

Sponsored By Pluris

Banking & Capital Markets
Finance & Risk Management

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The Black-Scholes model is in widespread use among reporting entities and accountants - even though research shows, and most people realize, that the model overvalues illiquid instruments. This white paper argues that current fair value accounting rules require considerations of factors (e.g. liquidity) which Black-Scholes was never designed to consider, and cannot consider. An approach that adjusts valuations for liquidity is more appropriate and accurate. This applies to any fair value measurement subject to the principles of FAS 157, including valuations of warrants, options, and embedded derivatives like optionality or conversion options.
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Released: April 16, 2012
Length: 18 pages
Format: PDF (1441 kb)
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