Models and Markets:
Option Theory and the Construction of Derivatives Markets
7 March 2007
Lecture Theatre 1
11 Crichton Street
The talk will be followed by a reception.
What difference does it make to a market for there to be a well-regarded mathematical model of the market, especially one that is not just an external analysis by academics but is used by market practitioners?
This talk will ask this question mainly in regard to the most famous model in modern financial economics, the Nobel-Prize winning Black-Scholes-Merton model of option pricing, which is the core mathematical foundation of the global market in ‘financial derivatives’. (At the end of June 2006, derivatives contracts outstanding worldwide totaled $454 trillion, the equivalent of nearly $70,000 for every human being on Earth.)
The talk will describe how the practical uses of the model initially had the effect of making markets more like the postulates of the model, but will discuss how this effect reversed in direction in the 1987 stock market crash, with near-disastrous consequences for the global financial system.
No previous knowledge of economics will be necessary to understand the talk: what an ‘option’ and a ‘derivative’ are, and what the Black-Scholes-Merton model consists in, will be explained in simple terms.