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FISCHER BLACK and the REVOLUTIONARY IDEA of FINANCE ffirs.qxd 5/26/05 1:40 PM Page iii FISCHER BLACK and the REVOLUTIONARY IDEA of FINANCE PERRY MEHRLING John Wiley & Sons, Inc. ffirs.qxd 5/26/05 1:40 PM Page ii ffirs.qxd 5/26/05 1:40 PM Page i FISCHER BLACK and the REVOLUTIONARY IDEA of FINANCE ffirs.qxd 5/26/05 1:40 PM Page ii ffirs.qxd 5/26/05 1:40 PM Page iii FISCHER BLACK and the REVOLUTIONARY IDEA of FINANCE PERRY MEHRLING John Wiley & Sons, Inc. ffirs.qxd 5/26/05 1:40 PM Page iv Copyright © 2005 by Perry Mehrling.All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty:While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials.The advice and strategies contained herein may not be suitable for your situation.You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. Fischer Black’s published and unpublished work is quoted with permission of the estate of Fischer Black. Courtesy Alethea Black. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Merhling, Perry. Fischer Black and the revolutionary idea of finance / by Perry Mehrling. p. cm. ISBN-13 978-0-471-45732-9 (cloth) ISBN-10 0-471-45732-9 (cloth) 1. Black, Fischer, 1938– 2. Finance—United States—History—20th century. 3. Economists—United States—Biography. 4. Finance—Mathematical models. 5. Investments—Mathematical models. I. Title. HG172.F53M44 2005 332'.092—dc22 2005007460 Printed in the United States of America. 10987654321 ffirs.qxd 5/26/05 1:40 PM Page v To Judy ffirs.qxd 5/26/05 1:40 PM Page vi ffirs.qxd 5/26/05 1:40 PM Page vii The true search for knowledge is not like the voyage of Columbus but like that of Ulysses. Man is born abroad, living means seeking your home, and thinking means living.... A cowardly fear of thinking curbs us all; the censorship of public opin- ion is more oppressive than that of governments. Most writers are no better than they are because they have ideas but no character.... To be original you must listen to the voice of your heart rather than the clamor of the world—and have the courage to teach publicly what you have learned.The source of all genius is sincerity; men would be wiser if they were more moral. Ludwig Borne (1823), quoted in Rudolf Flesch, How to Make Sense (1954) ffirs.qxd 5/26/05 1:40 PM Page viii ftoc.qxd 5/26/05 1:40 PM Page ix Contents Acknowledgments xi Prologue The Price of Risk 1 ONE Thou Living Ray of Intellectual Fire 23 TWO An Idea in the Rough 49 THREE Some Kind of an Education 73 FOUR Living Up to the Model 99 FIVE Tortuous Economic Intuition 121 SIX The Money Wars 141 SEVEN Global Reach 167 EIGHT Stagflation 191 NINE Changing Fields 217 TEN What Do Traders Do? 235 ELEVEN Exploring General Equilibrium 259 Epilogue Nothing Is Constant 287 Notes 303 References 327 Index 355 ix ftoc.qxd 5/26/05 1:40 PM Page x flast.qxd 5/26/05 1:41 PM Page xi Acknowledgments his book has been seven years in the making.Along the way I have received help from very many people, in very many forms. My T largest debt is to Fischer’s family, especially to Cathy Tawes Black, who provided access to Fischer’s extensive professional files at MIT as well as student records at Harvard, and to Fischer’s parents (now de- ceased), who welcomed me to their Tampa home and opened the family archives to me. Fischer’s siblings Blakeney and Lee, his daughters (especially Alethea), his ex-wives Cynthia Linton and Miriam Black, and his cousin Stanley Black and aunt Corinne Black all provided in- valuable help in understanding issues of character. I am also indebted to Fischer’s high school buddies, college and graduate school roommates, friends and housemates, for their insights. The most important intellectual influences on Fischer were Jack Treynor and Merton Miller, whose help and support were therefore especially valuable and appreciated, especially that of Merton Miller, who took the time to meet with me despite his own failing health. Thanks also to Franco Modigliani, whose passionate advocacy of neo- Keynesian orthodoxy gave Fischer something to respond to, and to Serena Modigliani for access to her husband’s papers, which allowed me to trace the origin of Fischer’s interest in macroeconomics and monetary theory. Special thanks also to Robert Merton and Myron Scholes, whose lives were from the beginning inextricably intertwined with Fischer’s on account of the options formula. My interest in writing about Fischer Black stemmed originally from xi flast.qxd 5/26/05 1:41 PM Page xii I xii I ACKNOWLEDGMENTS an interest in understanding the evolution of twentieth-century Ameri- can monetary thought, and initially I conceived of the book as provid- ing a window on certain ideas and institutional developments in finance that have transformed both the way banking is done and the way we think about it. The book was supposed to carry into the present the story I had begun to tell in my previous book The Money Interest and the Public Interest,American Monetary Thought,1920–1970. Fischer Black was clearly the best subject on whom to hang such a story since he, more than anyone else of his generation of financial economists, maintained a lifelong engagement with the problems of macroeconomics and mone- tary theory. In my original conception, the research for the project was to be almost entirely archival. I owe thanks especially to Nora Murphy and Jeffrey Mifflin for their help during a summer spent at the MIT In- stitute Archives and Special Collections. My original project survives as Chapters 6 through 8 in the present volume, but the initial research revealed that there was an even larger story that needed to be told, namely the story of the rise of modern fi- nance itself. For this story also, the career of Fischer Black seemed to provide an almost perfect narrative frame, since he spent his life strad- dling the world of academia and the world of practical business.As I was expanding my sense of the project, Pamela van Giessen at John Wiley & Sons approached me with the suggestion to expand my horizons even more. She urged me to write a book that would not only straddle the worlds in which Fischer lived, both academia and business, but also the personal life that supported the intellectual venture of this unusual mind. I was intrigued by the challenge, but also more than a little intim- idated. I thank my agent Susan Rabiner for helping me to discover how concretely to proceed. In the end, I interviewed more than a hundred people, some several times. It soon became clear to me that Fischer had the habit—I would go so far as to call it an intellectual strategy—of gravitating to people he thought he could learn from.The key to understanding the evolution of his ideas was therefore to find the people he was interacting with at each stage in his life. In each setting—Arthur D. Little (ADL), Wells Fargo Bank, the University of Chicago, the Massachusetts Institute of Technology, and Goldman Sachs—there was a different group, but in every case I found that group more than willing to share with me their remembrances of interactions with Fischer. The overall intellectual arc flast.qxd 5/26/05 1:41 PM Page xiii Acknowledgments I xiii I of the book would have been largely the same without these inter- views, but it would have lacked the texture and detail that make the story of ideas into a human drama. I owe a great debt to all who made time to talk with me, in person or by phone, over the years.
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