Option Pricing Models: From Black-Scholes-Merton to Present

Abstract

Its intuitiveness and the simplicity of its calculations make the seminal Black-Scholes-Merton option pricing model the most commonly known and used among all asset pricing models ever developed. Almost half a century after it was introduced, a massive literature has been devoted, and is still being generated, to empirical testing of the original model, to developing new models addressing its original assumptions and biases, and to extending the framework of option pricing. This article presents a review of fundamental option pricing models from Black-Scholes-Merton to the present day, covering alternative option pricing approaches, including those for options on different underlying assets as well as those with different asset price and volatility dynamics. This article also reviews contemporary topics in options, including applications to novel risks such as climate-related risks and volatility risk, as well as implementation of novel methodologies from data science and machine learning.