The Black-Scholes-Merton Model  • 33
Okay, even if the last assumption is a little hard to swallow, the first 
three sound plausible, especially if you have read something about the 
efficient market hypothesis (EMH). Suffice it to say that these assumptions 
express the “orthodox” opinion held by financial economists. Most finan-
cial economists would say that these assumptions describe correctly, in 
broad-brush terms, how markets work. They acknowledge that there may 
be some exceptions and market frictions that skew things a bit in the real 
world but that on the whole the assumptions are true.
Let us now use these assumptions to build a picture of the future 
stock price range predicted by the BSM.
Start with an Underlying Asset
First, imagine that we have a stock that is trading at exactly $50 right now 
after having fluctuated a bit in the past.
Advanced Building Corp. (ABC)
5/18/2012 5/20/2013 249 499 749 999
100
90
80
70
60
50
40
30
20
Date/Day Count
Stock Price
I am just showing one year of historical trading data and three years 
of calendar days into the future. Let’s assume that we want to use the BSM 
to predict the likely price of this asset, Advanced Building Corp. (ABC), 
three years in the future.
The BSM’s first assumption—that markets are efficient and stock 
prices are perfect reflections of the worth of the corporation—means that if