From Oxford Today, May 20, 2014:
By Dr Michael Black*There's actually a bit more to the guy. From Blackfriars Academic Staff page:
Did my uncle create the financial bomb that finally blew up the world economy in 2007–8? Put it this way: along with Myron S Scholes and Robert C Merton, Uncle Black (Fischer Black to everyone else) was credited in the early 1970s with formulating the mathematical model that led to derivatives.
To cite just one post-Lehman historian: “Without derivatives, leveraged bets on subprime mortgage loans could not have spread so far or so fast. Without derivatives, the complex risks that destroyed Bear Stearns, Lehman Brothers, and Merrill Lynch... could not have been hidden from view... Derivatives were the key; they enabled Wall Street to maintain its destructive run until it was too late.”
What is a derivative? In essence, it is a financial contract that derives its value from the performance of another entity such as an asset, index or interest rate. It is one of three categories of financial instrument, the other two being equities (stocks) and debt (mortgages and bonds).
Derivatives were made possible by a mathematical model of financial markets devised by Black and Scholes, from which a formula of financial valuation followed. The Black-Scholes model was first aired in their 1973 paper ‘The Pricing of Options and Corporate Liabilities’, published in the Journal of Political Economy.
Black-Scholes also allowed the financial valuation of a company – any company, of any sort, anywhere in the world – which is shown to be a function of the price of its options that are traded in the market (and vice versa). It became the E=MC2 of the world of finance, its Gold Standard.
The most important thing to bear in mind is that at the time, and for three decades, the theory was seen to be progressive as well as brilliant. Merton and Scholes received the Nobel Prize for it in 1998 (Fischer had died in 1996 and the Nobel Prize is not awarded posthumously).
Black-Scholes was accepted by academics, by analysts, by traders, by rating agencies and by virtually all investment institutions as a representation of financial reality. Black-Scholes is probably the closest the world has ever come to a universal standard of financial value.
The Black-Scholes idea of value reigned supreme... right up to the moment in 2007 when it didn’t. Almost overnight, the model became suspect and the world financial system ground to a halt. Investment portfolios from Darien to Düsseldorf became ‘toxic’ because the Black-Scholes presumptions were suddenly recognised as bogus and the ‘real’ value of assets purchased was consequently indeterminate.
One could choose to view the entire Black-Scholes ‘boom to bust’ life cycle as one instance of a much broader pattern of post-1945 capitalism in which government financial controls were gradually relaxed, but at the expense of stability. That’s a very synoptic view suggested by the newly-published Cambridge History of Capitalism.
However, that’s not what it seemed like half a century ago. Corporate finance was in its infancy and beamed with the sort of promise we associate with the eighteenth- century Enlightenment – applying reason and science to human problems previously left to luck and quackery.
Born in 1938, Uncle Black was a maths and science geek who went to Harvard. By the mid-1960s he stood at the very dawn of a world we have since taken (and still take despite 2007–8) for normal, with investment management by ‘scientific method’, as opposed to the sort of craft practice that had prevailed before.
But the supposedly universal quality of Black-Scholes was to prove its undoing. The failure of this measure of value was systematic: that is, it affected everyone, everywhere simultaneously precisely because it was employed universally, its collective wheel greased by technology. Modern financial theory was supposed to eliminate risk, yet it had done the reverse.
This self-defeating character of a universal measure of value then raises a second issue. Is an objective measure of corporate value possible to formulate even if it’s not universal; let’s say, for an industry or a sector?...MORE
Michael Black
After a career in business with McKinsey & Company, Coopers & Lybrand Europe and the American Stock Exchange International, Michael returned to Oxford to complete his doctorate in the moral theology of corporate life. He also holds an MBA in theoretical finance from the Wharton School of the University of Pennsylvania at which he was departmental vice-chairman under Russell Ackoff. Michael has previously taught corporate finance and strategy in various MBA and university executive programmes in The Netherlands, Sweden and Germany. He currently lectures and tutors on the ethics of the corporation, and is Librarian at Blackfriars Hall.
