Pricing the Future

October 1, 2011
Mathematician and financial economist Szpiro (Numbers Rule: The Vexing Mathematics of Democracy, From Plato to the Present, 2010, etc.) chronicles the co-evolution of modern finance, physics and statistics. In 1997, the Nobel Prize was awarded to economists Myron Scholes and Robert Merton for determining "the true value of an option," just one year before the billion-dollar hedge fund they founded nearly collapsed global financial markets. The prize was based upon their discovery--along with their deceased collaborator Fischer Black--of a formula that laid the basis for computerized derivatives trading. In the author's opinion, despite the spectacular real-world failures of their model, which also contributed to the 2007 economic crisis, on a scientific level, their achievement "is a landmark achievement of the twentieth century." While this may strike readers as unwarranted hyperbole, Szpiro unravels the complexity of the Black-Scholes equation and its fascinating relationship to Einstein's application of statistics in explaining the random motion of molecules and to Norbert Wiener's discovery of Cybernetics (based on his World War II work on target acquisition). In the case of options, it is option prices rather than molecules that jiggle. The author devotes most of the text to tracing "the historical and intellectual developments that led to the options pricing formula," beginning more than 300 years ago with the tulip bubble, when frenzied speculators drove the price higher and higher until the bubble burst and buyers defaulted on future contracts. An interesting history of mathematics and its application to economics and the world of high finance.

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November 1, 2011
Various financial instruments to protect investors against losses in capital markets have developed over the centuries. Mathematical historian Szpiro (Poincar''s Prize, 2007) ambles through one of the oldest such derivatives, the option. Traded today in huge volumes, an option contracts buyer and seller to a right to exchange a share of stock at a defined price in the future. But determining an option's correct price was a challenge until three math whizzes published their solution in 1973. Recounting the lineage of the options-pricing equation, Szpiro launches from an example of irrational exuberance that led to ruinHolland's tulip mania in the 1630sinto the Paris bourse of the late 1800s, when a series of math-minded characters pondered the pricing problem. As their biographies, some quite dramatic and tragic, carry his narrative forward, Szpiro covers how they borrowed from physics its formulas about the random movement of atoms, which they then applied to volatile stock prices. Culminating with a comeuppance to intellectual hubristhe implosion of the equation-solvers' investment firm in 1998Szpiro's tale should fascinate readers who follow the markets.(Reprinted with permission of Booklist, copyright 2011, American Library Association.)