Physicist, Startup Founder, Blogger, Dad

Saturday, March 03, 2012

Derivatives history

I'm writing a review (for Physics World) of a recent book on the history of options pricing, and I'm collecting a few links here so I don't lose them. Please ignore this post unless you are interested in arcana ... the actual review will appear here eventually.

AFAIK, high energy physicist M.F.M Osborne was the first to note log-normal behavior of stock prices. (Bachelier, who amazingly gets so much credit, proposed arithmetic Brownian motion, which neither fits the data nor makes logical sense.) Osborne's book is quite interesting as he explores market microstructure, market making, supply-demand (bid-ask) in detail, going far beyond the usual idealizations made by economists. I had a library copy out years ago but perhaps I should actually buy my own someday. Of course modern HFT types have gone far beyond Osborne's work in the 1950s.

Mathematician Ed Thorp (of Beat the Dealer fame) obtained the Black Scholes equation years before Black and Scholes, but kept it a secret in order to trade on it for his fund. He also first obtained the correct pricing for American options. That he was way beyond Black and Scholes intellectually seems pretty obvious to me. Thorp's web site.

I wish I could remember whether MacKenzie got all this right.

First regulated futures market involved trading of rice in 17th century Japan.


Teich50 said...

In Niall Ferguson's book "The Ascent of Money", he discussed the Dutch "nascent futures market" (for VOC shares) that was operating in 1611.

Al_Li said...

Ed Throp also detected Madoff was a fraud before everyone else, and withdrew his money from Madoff's fund.

Jason Tigg said...

Check out http://en.wikipedia.org/wiki/Louis_Bachelier

Seventy three years before Black and Scholes wrote their famous paper in 1973 [5], Bachelier had derived the price of an option where the share price movement is modelled by a Wiener process and derived the price of what is now called a barrier option (namely the option which depends on whether the share price crosses a barrier). Black and Scholes, following the ideas of Osborne and Samuelson, modelled the share price as a stochastic process known as a Geometric Brownian Motion (with drift).

binaryoptionsbinaires said...

For the lay person, the Black-Scholes model is explained at http://black-scholes.co.uk

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