Pricing the Future: Finance, Physics, and the 300-year Journey to the Black-Scholes Equation

Pricing the Future: Finance, Physics, and the 300-year Journey to the Black-Scholes Equation

George G. Szpiro

Language: English

Pages: 320

ISBN: 0465022480

Format: PDF / Kindle (mobi) / ePub

Options have been traded for hundreds of years, but investment decisions were based on gut feelings until the Nobel Prize–winning discovery of the Black-Scholes options pricing model in 1973 ushered in the era of the “quants.” Wall Street would never be the same.

In Pricing the Future, financial economist George G. Szpiro tells the fascinating stories of the pioneers of mathematical finance who conducted the search for the elusive options pricing formula. From the broker’s assistant who published the first mathematical explanation of financial markets to Albert Einstein and other scientists who looked for a way to explain the movement of atoms and molecules, Pricing the Future retraces the historical and intellectual developments that ultimately led to the widespread use of mathematical models to drive investment strategies on Wall Street.















combined with high leverage and dangerous doses of greed and arrogance, can add up to a highly toxic mixture to which even the smartest doctors, Ph.D.s that is, have no antidote. EIGHTEEN The Fat Tails CAPITAL MARKETS AND THE MARKETS FOR DERIVATIVES form the foundations of a modern economy. By matching entrepreneurs who require money to operate and expand their businesses and investors willing to put their savings at the businesspeople’s disposal, capital markets allow an economy to

bargain rates, much to the chagrin of creditors who received only a fraction of what they had initially lent. The damage to the trustworthiness of the credit market was immeasurable. In 1793 the bourse was closed and remained shut for four years, even after the bloody Reign of Terror had ended, during which 40,000 people were executed by the guillotine. Soon the economic situation became untenable. In August 1795 the franc was declared legal tender, and in September 1797 the state reneged on

intellectual tools to pen a treatise that anticipated future developments by dozens of years remains a mystery. Probably Jules sat down to work on his 50,000-word essay in the evenings, after a full day’s work at the bourse, in the small room under the attic that he shared with his brother. A year after he started as an assistant at the stock exchange, he had developed—all by himself—a theory of financial markets that presaged work that would win the Nobel Prize in physics and in economics in the

his summers pursuing pastimes such as photography and fishing and boating on the lake of Enghien-les-Bains. When Regnault died in December 1894, he left behind a considerable fortune valued at just over a million francs, comprising bonds, stocks, and real estate. In today’s currency this would correspond to about $3.5 million, depending on how purchasing power is taken into account. Since Jules never married, the beneficiaries of his estate were his mother, his sister, some distant cousins, the

plus ⅙ times five, plus ⅙ times six. This gives 3.5, which is the expected number of pips at the throw of a dice. The fact that the “expected” number of pips can never actually occur is only one of the incongruencies of probability theory that so bothered mathematicians at the time .2 But at least the computational method seems straightforward enough, doesn’t it? Well, it is not quite as simple as that. What if the number of potential outcomes is infinitely large and the probabilities are

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