In the Black-Scholes framework, return volatility is assumed to be constant over the life of the option. This is not theoretically appropriate for pricing options on (default-risk-free) bonds because
A) Empirically, interest rates are known to change over time, so bond volatility will change over time.
B) Even if interest rates are constant over time, the duration of the bond will change over time, and duration is a measure of volatility.
C) Constant return volatility on a zero-coupon bond is possible only if the bond price does not change over time.
D) The bond price at maturity is known for certain, so volatility must go down as maturity approaches.

Question

In the Black-Scholes framework, return volatility is assumed to be constant over the life of the option. This is not theoretically appropriate for pricing options on (default-risk-free) bonds because 
A) Empirically, interest rates are known to change over time, so bond volatility will change over time.
B) Even if interest rates are constant over time, the duration of the bond will change over time, and duration is a measure of volatility.
C) Constant return volatility on a zero-coupon bond is possible only if the bond price does not change over time.
D) The bond price at maturity is known for certain, so volatility must go down as maturity approaches.

Quizplus · Accepted Answer

The Answer of In the Black-Scholes framework, return volatility is assumed to be constant over the life of the option. This is not theoretically appropriate for pricing options on (default-risk-free) bonds because 
A) Empirically, interest rates are known to change over time, so bond volatility will change over time.
B) Even if interest rates are constant over time, the duration of the bond will change over time, and duration is a measure of volatility.
C) Constant return volatility on a zero-coupon bond is possible only if the bond price does not change over time.
D) The bond price at maturity is known for certain, so volatility must go down as maturity approaches.

In the Black-Scholes Framework, Return Volatility Is Assumed to Be