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Pit Stops:
Black and Scholes Make a Name |
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Black and Scholes made their names with the Black-Scholes formula, a method of pricing options that was first published in 1973 in the University of Chicago's Journal of Political Economy. Just one month before the formula's publication, the Chicago Board of Options Exchange had opened, providing the first formula market for options trading. |
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Options give investors the opportunity, but not the obligation, to buy or sell assets at a prespecified price. Until the Black-Scholes formula, investors in share options, futures, and other derivative securitiescalled derivatives because their worth is affected by, or derived from, fluctuations in the value of other assetscould not be sure of the value of their securities. Many researchers tried to determine the value with formulas that required assigning risk premiums. Black and Scholes realized that a stock's price already reflected the options risk and devised their famous formula accordingly. |
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In the past quarter century, the options market has exploded, with the Black-Scholes formula awarded much of the credit. In the first nine months of 1997, the Wall Street Journal reported, the value of U.S. exchange-traded options reached $155 billion. |
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"Nowadays, thousands of traders and investors use the formula every day to value stock options in markets throughout the world," wrote the Nobel committee. "Such rapid and widespread application of a theoretical result was new to economics." |
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Merton Miller, who influenced the work of Black and Scholes and published his own article on option valuation in 1973, generalized the formula, taking it beyond options on shares and applying it to other derivatives. The Black-Merton-Scholes methodology has been used, for example, to design optimal financial contracts and to determine values of insurance contracts and guarantees. |
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