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

George G. Szpiro

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Book Description

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.

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Franklin Allen, Nippon Professor of Finance and Economics, The Wharton School of the University of Pennsylvania "George Szpiro has written a wonderful book. Often finance is viewed as one of the driest of fields. Szpiro makes the history of the option pricing formula fascinating at many levels. He starts with the history of options, bringing in the Tulipmania, the Dutch East India Company, the Amsterdam Bourse, Joseph de La Vega, John Law's colorful life and on and on. The mathematical tools needed for deriving the formula and the people who developed them are also heroes of the tale. The climax is reached with Fisher Black, Myron Scholes and Robert Merton's time together at MIT and the derivation of the formula that revolutionized finance. It is a book that is very difficult to put down. This will be true for beginning students of finance as well as the highest earning traders. I thoroughly recommend it!" Andrew Lo, Harris & Harris Group Professor of Finance and Director of the Laboratory for Financial Engineering, Massachusetts Institute of Technology "This is a fascinating historical account of the origins of modern finance and the Black-Scholes/Merton option-pricing formula, by a consummate expositor who also happens to be a first-rate financial economist. Those who think finance is a science will be surprised by the serendipitous events that delayed the discovery of the option-pricing formula by 73 years; those who think finance is an art will be shocked by the deep connections between option-pricing, physics, and probability theory. No matter what your background, you'll want to read this book slowly--like a rare vintage port, it's meant to be sipped slowly and every drop savored." Robert P. Inman, Richard K. Mellon Professor of Finance and Economics, The Wharton School of the University of Pennsylvania "One of the major intellectual achievements of the 20th century was the theory of option pricing. This is its story, and it's absolutely fascinating. Options have been around since the buying and selling of tulips and the very first efforts of investors to control their downside risk. But the economic value of such protections was not finally understood until the Nobel Prize winning research of Fischer Black, Myron Scholes, and Robert Merton in the 1970's. It could not have happened without 350 years of serious thinking by botanists, physicists, chemists, and mathematicians. Finally, by 1960 all the pieces were in place, and Black, Scholes, and Merton solved the puzzle. The book should be required reading of all first year PhD students in finance, and economics, simply to see what is needed for path-breaking research. For the rest of us with an interest in the origins of important ideas, this is a great read." Sylvia Nasar, author of Grand Pursuit: The Story of Economic Genius and A Beautiful Mind: The Life of Mathematical Genius and Nobel Laureate John Nash "George Szpiro's crisp prose, clever vignettes and refreshingly concise explanations make finance history go down like gelato on a summer's day." Kirkus Reviews "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. In the case of options, it is option prices rather than molecules that jiggle... An interesting history of mathematics and its application to economics and the world of high finance." Booklist "Recounting the lineage of the options pricing equation, Szpiro launches from an example of irrational exuberance that led to ruin--Holland's tulip mania in the 1630s--into the Paris bourse of the late 1800s, when a series of math-minded characters pondered the pricing problem. As their biographies, some quite d

About the Author

George G. Szpiro is a mathematician, financial economist, and journalist. He is the Israel correspondent of the Swiss daily Neue Zurcher Zeitung and has published in Science, Nature, and the Jerusalem Report. He is the author of Kepler's Conjecture, The Secret Life of Numbers, Poincare's Prize, and Numbers Rule. He lives in Switzerland.

Product details

  • Format: Kindle Edition
  • File Size: 682 KB
  • Print Length: 322 pages
  • Page Numbers Source ISBN: B008PGL4HO
  • Publisher: Basic Books (29 Nov. 2011)
  • Sold by: Amazon Media EU S.à r.l.
  • Language: English
  • ASIN: B005OVTBD2
  • Text-to-Speech: Enabled
  • X-Ray:
  • Word Wise: Enabled
  • Enhanced Typesetting: Not Enabled
  • Amazon Bestsellers Rank: #177,336 Paid in Kindle Store (See Top 100 Paid in Kindle Store)
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Most Helpful Customer Reviews on (beta) 3.9 out of 5 stars  15 reviews
9 of 9 people found the following review helpful
5.0 out of 5 stars Very interesting 27 Jan. 2012
By Simon Z. Benninga - Published on
I really liked this book. It does a great job of summarizing the intricate history of the mathematics behind the Black-Scholes formula. The biographical details were fascinating, and ultimately the reader gets a good feel for why this is such an important problem (and why several Nobel prizes were awarded for this pathbreaking achievement).

An extensive very complementary review can be found in the Economist magazine: [...] .

In the realm of full disclosure: I read an early draft of a chapter of the book and made some comments.
27 of 34 people found the following review helpful
2.0 out of 5 stars Rather boring vs other books on the subject 21 Dec. 2011
By Gaetan Lion - Published on
Format:Hardcover|Verified Purchase
The author has an encyclopedic knowledge about the subject. But, he does not convey the material in a user friendly way. Additionally, his attempt at explaining the basics of the Black Scholes (BS) formula within the Appendix is truly obfuscating. Within this section after 12 laborious algebraic steps, he ends up with a different trigonometric formula that does not look like the BS equation. Thus, don't buy this book to acquire a clear understanding of this formidable formula.

As a historian, the author has done superb research. He does a good job at connecting the dots of the various luminaries across time that established the theoretical preceding foundation that allowed for a team of three contemporary geniuses to put it all together in 1973 (Black, Scholes, Merton).

Yet, the author lingers on certain topics way too long for the sake of his book's rhythm. At the beginning, his studies of investment manias (tulip bubble, the Mississippi and the East Indies bubble) goes on for too long. Then, his exploration of the Brownian movement whereby particles move by the square root of time (which applies to stock price movement too) is so lengthy it dominates the entire book. He narrates how numerous scientists from many different disciplines uncovered this perplexing principle independently. By the third time that such a scientist had rediscovered that principle, I began to get cross eyed. Actually, this book is more about Brownian motion than the BS formula.

The last quarter of the book is the better one. All of a sudden the author realized he had much ground to cover and got moving. His description of the three main protagonists (Black, Scholes, Merton) is good. Chapter 17, on the failure of Long Term Capital Management where Scholes and Merton were cofounders is good. The last chapter on the limitation of any models, especially the ones based on the Normal distribution is good too.

However, if you are interested by this subject I recommend two other books that are far more readable and interesting:Fischer Black and the Revolutionary Idea of Finance and When Genius Failed: The Rise and Fall of Long-Term Capital Management.
4 of 4 people found the following review helpful
3.0 out of 5 stars Not pricing the future 28 Oct. 2012
By Gderf - Published on
Format:Kindle Edition
The title is overly pretentious. This is a fine history of the transition from the mathematics related to Brownian motion to Black-Scholes option pricing equations. The book starts with the pretentious statement that B-S is as important as Newton's laws of motion. The technical portion of the book suffers from excessively bad editing: surface for circumference, banker for baker (hedger), receives for pays and there is an instance where option buyer and writer are reversed. It's a well researched and informative history of development of statistical applications to science and finance. It's especially informative on the contributions of under appreciated scientists like Louis Bachelier and relative unknowns like Jules Regnault and Paul Levy.

There's interesting coverage of Norbert Weiner and the development of cybernetics, as related to finance. Szpiro does a good job relating how Harry Markowitz and others modernized the work of Bachelier, leading to Nobel prizes for Markowitz, Merton and Scholes. The book examines minutely the entrance of "quants" into the field of derivative finance. There's a very good history of LTCM, with its founders, methods and failure. It might be the best available, although the reason for potential bank losses provoking federal intervention is not made clear.

Except for the LTCM case and an attempt in the last chapter, limitations and failures of statistical applications are not covered. The attempt in the last chapter is based solely on statistical considerations. Brownian motion is significant only in a closed environment. In a stream or an ocean it's a small component of particle motion. A financial market is more like an ocean than like a petri dish. Finance is subject to biases and exogenous variables that are likely to have more effect than the statistics of randomness. This is especially true of currency hedging. It's very difficult to see how the Russian devaluation and bankruptcy that sunk LTCM could have been subject to statistical analysis. Szapiro doesn't clarify the point.

Derivation of the B-S option pricing equations from the statistics of Brownian motion is better done elsewhere, as by Jarrow or Bookstaber. This is a very informative history of both science and finance; too bad it tries for more. Don't expect it to fulfill the ridiculous expectation of the title.
3 of 3 people found the following review helpful
5.0 out of 5 stars Very well done 26 Sept. 2012
By Don M. Chance - Published on
Format:Kindle Edition
This is a very good book for anyone who has ever calculated an option price. (If you have not, don't read it.) I knew a good bit of this story but only in scattered unconnected pieces. The author has done a great job of assembling the history of the model back to its roots and tying things together. The research is the kind of meticulous work you find in historians (good ones, at least). I'm not sure why there were some negative reviews, but clearly no book can meet all expectations. I highly recommend it, though it's not a good mothers day gift (unless mom's a quant!). If you have any doubt, order this book and something completely different to hedge your risk. (That's what I did.)
1 of 1 people found the following review helpful
4.0 out of 5 stars Vignettes from the prehistory of math finance 20 Dec. 2012
By David J. Aldous - Published on
Format:Hardcover|Verified Purchase
300 years of precursors to the Black-Scholes option pricing formula are traced via accounts of the lives and works of a dozen or so major characters and another dozen minor characters. This is nowadays a common format for popular science writing (used e.g. for Bayes rule in The Theory That Would Not Die), and here it is executed well -- the writing style and content is engaging and appropriately non-technical. The choice of topic is intrinsically cross-disciplinary (mathematics theory, economics theory, practical market speculation) and by incorporating also the author's own physics background, a book emerges that is pleasingly different from other popular science accounts of these topics and characters (typically written from the viewpoint of one particular academic discipline, or none in the case of journalistic authors).

Here is a precis of the relevant standard history, from a mathematician's viewpoint. For various reasons [mathematicians couldn't make it fit with the rest of math, and physicists perceived the world in terms of deterministic laws], in 1900 mathematical probability had not yet become a coherent discipline. In particular there is a fundamental mathematical "square root law" providing a rough description of the cumulative effect of purely random fluctuations. Before 1900 this had been observed and explained in various contexts but not appreciated as a widely-applicable fact. Over the first third of the 20th century this (quite simple) law, the associated "Normal approximation" and the more technically sophisticated notion of the Wiener process as the fundamental model of "purely random" continuous fluctuations, all became well understood. The Wiener process was subsequently recognized as a mathematically fundamental and interesting object, and studied deeply by mathematicians and in several applied disciplines. During this time period and previous centuries, the relevance of such probability models to finance (stock prices and options thereon) was repeatedly realized by scattered individuals, but their theories never were widely used by speculators nor joined any academic mainstream. Until in 1973 Black and Scholes published their explicit formula for fair option prices (based on the Wiener process model for price fluctuations), fortuitously at the time when the Chicago Board Options Exchange opened and when electronic calculators became available to use the formula quickly, and mathematical finance blasted off.

The book does a fine job of adding color and Physics counterparts to this history, and of giving verbal explanations of some of the mathematics, though by emphasizing individual stories it may not leave the reader with a very accurate big picture.
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