This discussion centers on the development of the Black-Scholes options pricing model, and how it has influenced both the career of Professor Myron Scholes and the world of finance.
A Conversation With Myron Scholes
Basically an option is their right but not the obligation to buy security at a fixed price over a set period of time. That's called a call option. And there's also other options which give you that right but not the obligation to do so to salvage security at a set price over a specified time period. So the interesting thing about options are basically they are rights or ability to do something without the requirement to do something. So it's the flexibility or the optionality that we think about in life. And it's a similarily it applies to securities as well. So it could be equities could be bonds could be commodities correct equities bonds commodities commitments a lot of different things. OK so now let's go way back in time. Think of yourself in the late 1960s and a lot of things were going on in finance around that time major developments in the emerging field of financial economics. A lot of people had worked on how to price an option. Was a hard problem. And I'm just curious to hear how you actually got involved in this. I mean what was it that triggered your interest in solving this really hard problem. Well that's interesting. A long involved question but basically when I was at the universe Chicago as a Ph.D. student that was a bear as you mentioned a very embryonic time for the development of finance. It was a completely different way of looking at finance mostly from an economic perspective as opposed to a rules based perspective.
And it led to the development of finance as part of economics really and which was much different from the finances being Einav and syllabary sort of rules based way of thinking about things so at that time there was a great understanding of how to manage risk and the idea of thinking about risk is the idea of buying risky assets versus safe assets. That was one dimension of risk management and the other dimension of risk management was diversification. You know how you would diversify risky assets. And that led to development of things such as Bill Sharpes great discoveries and amplification of market which is work in talking about the capital asset pricing model and that for us was a great breakthrough because it was an equilibrium model of how assets individual assets should be priced relative to a benchmark or asset portfolio. And and that was one strand that was very prevalent. So that combination of risk and how to think about respect no one had really yet had thought about risk from that dimension of insurance and our area. A lot of people have talked about insurance from an actuarial way actuarial science. They had talked about pricing insurance from the idea of thinking about it only in the form of an option as I describe had a value option but no one had really thought about it in terms of an equilibrium context or thinking about how it fit into how assets were held how they were priced and the dynamics.
And that fascinated me when I before I went to MIT as an assistant professor and when I went to MIT as an assistant professor it was mandatory at the time that master's students in the then the Sloan probe at the Master's program had to write a thesis and several students came to me and asked me to be their adviser and they had option pricing.