ON APPLICABILITY OF BLACK-SCHOLES MODEL TO MSE

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